W. D. Gann once aptly remarked, “I’ve discovered that more than 90% of traders who step into the market without preparation or adequate knowledge usually incur significant losses in the end.”
A major support tool in situations where you might question whether to enter or exit trades is the use of Technical Indicators. They offer some degree of prediction accuracy regarding stock market movements, helping to increase your profit potential while minimizing risk. In layman’s terms, these indicators are essentially charts that depict market or price patterns. If interpreted correctly, they can guide you on whether market prices are likely to rise or fall, or whether stocks are overbearing or overstretched. These charts originate from a range of data points derived through application of a formula on an instrument’s price details, with the most basic being price/volume indicators.
Technical Indicators open up new perspectives in understanding an instrument’s price. Some, like MOVING AVERAGES, are straightforward, while others, such as STOCHASTICS, are derived from more complex formulas. It’s generally advised when analyzing the stock market to follow up to two or three of these indicators that are compatible with each other. All brokerage firms offer charting capabilities for conducting technical analysis. Assistance in selecting a broker for trading can be found on top stock brokers, and further guidance on forex trading is available too.
There are two primary types of Technical Indicators:
1. Leading Indicators: These typically track price fluctuations, generating buy or sell signals. Though they often present more trading opportunities, following these indicators comes with an element of risk. Common leading indicators include:
– Commodity Channel Index (CCI)
– Momentum
– Relative Strength Index (RSI)
– Stochastic Oscillator
– Williams %R
Leading Indicators offer several benefits, including early warnings for entry or exit points. However, they also carry a risk of inaccurate signals, which can increase trading risks.
2. Lagging Indicators: These follow price changes but act retrospectively, hence their alternative name of Trend Following Indicators. While the signals can come later, increasing the risk, lagging indicators’ main advantage lies in their ability to capture and stay in a move for as long as it lasts. Examples include:
– Moving Averages
– MACD – Moving Average Convergence Divergence
In conclusion, maintaining a healthy balance when using Technical Indicators is key. While it may be ideal to have an indicator that reacts quickly, offering early market signals, such indicators may also give false signals, increasing risk. It’s therefore recommended to use complementary market indicators which can offset these shortcomings and reduce your risk.
About the author: Punit Gupta is an entrepreneur who trades stocks full time. He has a knack for building startups from scratch. Currently developing a brokerage selection platform titled Best Trading Brokerage, Punit studied at the Georgia Institute of Technology in Atlanta, where he worked with a startup for seven years before launching his own venture.
