CHAPTER - 10 (I)
Indicators (Part 1)
Indicators are technical tools that assist traders in studying the price movements & in predicting the market trend. Based on these indicators, traders decide their entry & exit points.
Indicators are of two types – leading & lagging indicators.
Leading indicators
The leading indicators indicate the reversal of the trend or the new trend before it occurs. Thus, leading indicators are pro-active or forward-looking. However, the leading indicators can raise false alarms & therefore, one should be careful while using the leading indicators.
Lagging indicators
The lagging indicators indicate the reversal of the trend or the new trend after it occurs. The lagging indicators are reactive. The lagging indicators follow the price & provide a delayed indication to the trader.
Moving average is an example of a lagging indicator. Moving average is rather a concept that is used in various indicators. We already learn the concept of moving average in the previous chapter.
Now let us see different indicators used by technical analysts:
1. Relative Strength Index (RSI)
The RSI is a leading indicator that shows the security's internal strength, especially when the share is trading sideways or in non-trending ranges. In addition, it indicates the reversal in the trend. The RSI oscillates between 0 to 100.
Formula to calculate RSI :
RSI = 100 – (100 / 1+RS)
RS = Average points gained/ average points lost
The RSI reading is between 0 to 30, indicating an oversold market ready for an upward correction. Conversely, the RSI reading between 70 & 100 indicates an overbought market & is ready for a downward correction.
2. Moving Average Convergence & Divergence
MACD is the oldest indicator & most reliable indicator. Convergence is when the two moving averages move towards each other & divergence occurs when the two moving averages move away.
MACD value = (12 day EMA – 26 day EMA )
The negative MACD indicates a negative momentum in the stock & the stock is moving downwards. Whereas the positive MACD shows positive momentum in the stock & the stock is moving downwards.
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