Hello Traders, I'm Luke from disciplined trader.
This video is part of the trading basics series and in this one I want to introduce you to
indicators.
We will discuss at what they are, why they are used and look at some of the mostly commonly
used indicators by retail traders.
Indicators are on-chart studies that are used to enhance a trader's analysis of the particular
market they are looking at.
They do this by displaying the information about the movement of market price in a different
way from what you see on your chart.
Each different indicator tends to use a specific mathematical formula to look at the price
data from a different point of view.
They can be used to help a trader ascertain information about a market, for example, whether
it is currently in an uptrend or a downtrend.
They can also be used as entry and exit signals as a part of a trader's strategy.
Indicators can typically be split into two different types; lagging indicators and leading
indicators.
Lagging indicators, as the name suggests, lag the price movement.
The information and data these indicators show develops and changes as a result of past
price movement.
These indicators are typically the ones a trader would use to supplement their analysis
of a market.
Indicators such as moving averages and Bollinger bands are considered to be lagging indicators.
We'll look at these in more detail later in the video.
Leading indicators confusingly, still lag price (as sadly there aren't any indicators
that truly lead price (unless you're manipulating the price or have a working crystal ball!).
However, they are referred to as leading indicators as they are usually used to suggest that a
particular price move is likely to happen.
That is why these indicators are often used as entry and exit signals for trades.
Oscillating indicators such as the Relative Strength Index or (RSI) and Stochastic oscillator
are considered to be leading indicators as they both aim to show when a market is in
an oversold or over bought state and so a potential reversal may be imminent.
Again we'll look at these indicators in more detail a little later on.
It's generally accepted that a trader doesn't really need to use anymore than one lagging
and one leading indicator as part of their analysis and strategy.
The thinking behind this is that because lagging and leading indicators tend to be used for
the same purposes, having two or more could potentially give conflicting analysis.
For example, if a trader is using two leading indicators for entry signals, one indicator
could be telling them to enter a trade and the other may be indicating that they should
wait.
This would obviously only cause confusion and hesitation for the trader rather than
clarity and decisiveness.
However, as with a lot of things you will encounter in trading, this is just a general
rule of thumb.
There are exceptions to this and if you find two indicators of the same type that work
well together within your trading approach, don't let this put you off.
I also think that there's one type of common indicator that doesn't fall into these two
categories and that's volume based indicators.
The reason I don't think volume indicators can be classed as either lagging or leading
indicators, using the definitions we just looked at, is because they actually introduce
new data into the analysis.
Volume indicators look at how many transactions took place at different time periods and different
price levels, this data is not utilized by other indicators.
We'll also have a look at this type of indicator a little later on.
Now I want to introduce you to some of the most common indicators used by retail traders.
We'll look at what they look like, what they show and typically how they are used.
Let's start with probably the most commonly used of them all, moving averages.
Moving averages simply show how the average price of a market changes over time by plotting
a line on our chart.
Typically a moving average will look at the closing prices of each candle when calculating
the average, but this can usually be changed if needed.
The number of previous bars that a moving average looks at when calculating the average
can also be changed and is commonly referred to as the period.
So for example, you may have encountered a trader that uses a 200 period moving average
- this simply means that each point on the line is calculated by adding up the previous
200 bar's closing prices and dividing by 200.
The next bar forms and the same is done again and a new point plotted as so on.
When all these points are joined together this gives us a moving average line that we
can see on our chart.
There are two common types of moving average calculations, we have the simple moving average
(SMA) which we have just looked at and we have the exponential moving average (EMA).
An exponential moving average is calculated in much the same way as a simple moving average
is apart from an EMA will give more weighting to the more recent price points than the older
price points when calculating the average.
Now Fibonacci retracements and extensions can't really be classed as indicators, as
they are more a strand of support and resistance analysis.
But I have included them here as a trader will usually have to use the Fibonacci charting
tools in order to include this in their trading.
Basically Fibonacci retracements and extensions work on the principles of the significant
numbers thought to be discovered by a Leonardo Fibonacci in the 13th century (although the
sequence of numbers apparently appeared in India as early as the sixth century- but I
digress!).
They work by attempting to predict future support and resistance levels or trade targets
by measuring a price move and noting where the significant Fibonacci levels are based
on that initial price move.
The main levels used are the 23.6%, 38.2%, 50% and 61.8% levels.
Typically traders who use the retracements will look to enter a trade when a retracement
of the original move has been made to one of these Fibonacci levels.
Traders who use the extensions will look to take a trade in the direction of the original
move to a fib extension level The Average True Range is an indicator designed
to measure the volatility of the market it is used on.
The indicator uses a calculation to work out what is known as the true range of a market
and plots this in the same way a moving average plots the previous average close prices (as
we looked at earlier).
As with a moving average, a trader can change the period of the Average True Range indicator
to make it include more or less historical data.
Typically a trader will use the ATR to give them a gauge on how far a market is likely
to move in a given time period.
For example, if the 14 period ATR on the daily chart of the FTSE100 is 60 points, this would
give the trader an indication how much volatility to expect over the course of the trading day.
Bollinger bands, like the Average True Range, is another volatility indicator that also
uses a simple moving average.
This indicator has two bands that are calculated by plotting an upper and lower band two standard
deviations above and below the simple moving average used.
Because standard deviation is a measure of volatility, when the volatility in a market
changes, so to do the Bollinger bands.
In a low volatility market, the bands will be narrow as the price makes small moves.
Conversely when volatility is high, the bands will widen.
The Bollinger bands tend to encapsulate price for the majority of the time.
When price does move outside of the bands however, this is generally thought to show
that the price may be overbought or oversold depending on which band it has moved past.
Oscillator indicators such as the Relative Strength Index (RSI), Moving Average Convergence
Divergence (MACD) and stochastic oscillator are momentum indicators that are typically
used to identify when price is overbought and oversold in trending moves.
This information can be used to support an entry signal to trade in the direction of
the overall trend or can be used as a signal to get out of a trade as a potential retracement
may be imminent.
They show this information in different ways, the RSI and stochastic oscillator for example
demonstrate this potential overbought and oversold state through an oscillating line
that moves up and down between a scale of 0 to 100.
The regions between 0 and 20 are generally considered to be oversold and the regions
between 80 and 100 are considered to be overbought.
Some momentum indicators demonstrate this differently however, the MACD for example
has an oscillating line and a nine day ema which is used as a signal line.
When these two lines move away from each other significantly, this is the sign that the market
is potentially overbought or oversold depending on whether the line is above or below the
signal line.
Pivot points are again not really classed as an indicator as such, they too fall under
support and resistance analysis but I have included them as most charting packages have
dedicated pivot point studies that plot the daily pivots for you.
I also really like pivot points and use them every day in my trading, so wanted to make
sure I covered them at some point.
Pivots comprise of a central pivot and then three sets of pivots above and below the central
pivot, these sets of pivots are referred to as S/R1, S/R2 and S/R3 where the S stands
for support and the R stands for resistance.
These levels essentially act as intra-day support and resistance levels for price.
Some traders also like to use them as targets for trades.
The levels are calculated by looking at the previous day's high, low and close price.
Volume indicators as mentioned earlier, look at how many transactions took place at a particular
price point, they do not really care about the movement of price.
For example, if we were looking at a candlestick chart for a particular stock, a simple volume
indicator would show the trader how many transactions took place within that candle.
It is generally accepted that a large move one way or the other, should be accompanied
by high volume.
There are also other type of volume indicators such as the volume at price or volume profile
indicator that shows the volume at different price levels rather than within candles.
Some of you may be questioning how volume works in some markets like the currency markets
for example, where there is no central exchange so the amount of transactions isn't known.
In this situation, tick volume is often used as a substitute.
Tick volume is the number of times the price ticks up or down within a given time period.
This trading activity is measured in volume bars in exactly the same way volume would
be.
That covers a few of the most common indicators used today but as I am sure you'll soon find
out, there are literally hundreds if not thousands of indicators out there.
People are creating new indicators every day.
I'm sure if you haven't already, you'll see adverts by companies proclaiming that they
have created the world's best indicator, and using this indicator alone you will make 10
times your money in just one week, or some rubbish to that affect.
I'd like to think that anyone who listens to the advice on this channel would know that
this is not possible.
A single indicator alone will never make you profitable (unless it's that working crystal
ball we mentioned earlier!).
There are so many skills needed in order to become a profitable trader, a simple indicator
could never be a substitute for that.
Unfortunately these dodgy marketeers know that new traders are easy pickings when it
comes to selling people the trading dream.
Trading takes a lot of hard work and dedication, don't be one of the people that falls for
this type of scam.
Now I think it's worth saying that although the way in which you are supposed to use each
indicator is generally accepted, that doesn't mean it's the only way.
If you see an indicator being used in a particular way and think that it may be better utilized
in a different way, go for it!
As long as you test your idea before risking real money on it, what have you got to lose.
The more creative you are with your trading ideas, the better!
So that wraps up this introduction to technical analysis, I hope you have found it useful.
If you enjoyed the video, please feel free to drop a like on it.
If you have any questions or want me to cover any other topics in future videos, please
let me know in the comments below.
Also subscribe to the channel for more videos like this one.
I will be continuing this trading basics series to provide new traders with all the knowledge
they need to get started.
Thank you very much for watching and I hope you all have a good trading week.