Types of indicators/Oscillators

Before moving on to the next lesson, here’s the summary of the last three lessons: Technical indicators are tools that provide an indication about the condition or direction of the stock market. These indicators are generally used as additional information before one takes a decision to buy or sell a share. They provide unique perspective on the strength and direction of the market. Oscillators are a type of technical indicator. Most of the indicators work on the principle of averages. For technical indicators, there is a trade-off between sensitivity and consistency. In an ideal world, we want an indicator that is sensitive to price movements, gives early signals and has few false signals (whipsaws). Sensitiveness of an indicator/oscillator to price movements in the market would depend on the time interval for which the indicator is constructed. For example a 5 day RSI would be more sensitive than a 14 day RSI. The 5 period RSI would have more overbought and oversold readings. It is up to each investor to select a time frame that suits his or her trading style and objectives. The shorter the period selected, the more sensitive the indicator becomes. If we increase the sensitivity by reducing the number of periods, an indicator will provide early signals, but the number of false signals will increase. If we decrease sensitivity by increasing the number of periods, then the number of false signals will decrease, but the signals will lag and this will skew the risk reward ratio. From here on, for ease of understanding, we will discuss the prominent types of technical indicators/oscillators from the point of view of what exactly it measures. Whether it is leading or lagging and whether it’s signals are crossovers or not would be discussed at appropriate places. Prominent indicators/oscillators. Indicators that show the trend Moving average MACD (Moving average convergence/ divergence) Average directional index. Indicators that show momentum RSI (relative strength index) Stochastic oscillator Williams %R Indicators that measures volatility Average true range Bollinger bands Before moving further, I would also like to explain in brief about the difference between trend, momentum and volatility. Momentum- It measures the degree of acceleration in a stock price. It is a short term measurement. In other words, Momentum measures the speed of price change and provides a leading indicator of changes in trend. When momentum slows, this is taken to mean that there might be a change in direction. Momentum is significant because it signals the strength of price trends Trend – A trend can be defined as the general direction in which the market is moving in. A trend can be either upwards (bullish trend) or downwards (bearish trend) or sideways (lack of direction). Volatility – The relative rate at which the price of a stock moves up and down If the price of a stock moves up and down rapidly over short time periods, it has high volatility. If the price almost never changes, it has low volatility. In other words, Volatility refers to the amount of uncertainty about the swings in price of a stock. A higher volatility means that a stock’s value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security’s value does not fluctuate dramatically, but changes in value at a steady pace over a period of time