Trend Indicators – Moving Averages
As described above a moving average indicator is a trend indicator, it smoothes out the chart to enable a clearer view of the existence of a trend. There are three types of moving averages the simple, weighted and exponential. The simple moving average is the most popular. The difference between the three types of moving averages is the significance or weight given to each period. The simple moving average gives an equal weight (average) to all the periods taken, while the weighted and exponential moving averages give the most recent periods a stronger rating. All moving averages work in essentially the same way, every time a new period is added the last period is dropped off. When choosing a moving average the analyst should check the instrument over time to find a significant moving average over the period. For example off daily charts many traders like to use the 200-day moving average. A good moving average should behave in the following way; in a trending market the current price should not break the moving average line more than once. A second break of the moving average line is an indication of the end of a trend and a time to exit the position. If in a trending market the current price is breaking the moving average on more than one occasion yet the trend continues, then this is an indication that the moving average chosen is too fast (too few periods) and a longer period moving average should be selected. Some analysts use two moving averages to signify an earlier exit of a trend; if the faster moving average crosses the slower one then this would be an indication of the end of a trend. Essentially the slow moving average should act as a support or resistance line.
Volatility Indicators – Bollinger Bands
Bollinger bands work to set support and resistance points for an instrument. Like the moving average the Bollinger band can also be adjusted to suit the individual analysts trading style. The common practice is to use 2 standard deviation form the mean price. The bands will expand and contract from the mean price based on the volatility of the price. If the price breaks out either below or above the Bollinger band, than this could be an indication for a reversal or exit point in a strategy.
Oscillator Indicators – Stochastics
There are a couple of types of stochastics, the most common being the slow stochastic. Unlike the moving average and Bollinger bands the stochastic indicator appears on a separate chart below the actual price chart. The Stochastic oscillators are used to determine either the strength of a trend or when the end of a trend is approaching. Stochastics are displayed by two lines known as %K (Faster) and %D (Slower) that oscillate between a scale ranging from 0 to 100. The mathematics behind the oscillators is unimportant, the importance lies in the meaning and placement of the lines of the %K and %D lines. Apart from the the oscillating lines there appear two horizontal lines at 20 and at 80. When the lines cross above the 80, this is an indication of a strong upward trend, conversely below 20 represents a strong downward trend. When the %K line crosses over the %D line this could be an indication of a change in the trend, and a possible exit point. When the market is range bound the stochastics will appear crossing over themselves, indicating a trend less market. The strongest signal for the stochastics is when both lines are moving in the same direction after a turn at the same time as the actual price chart; this is an indication of a trend. Alternatively when the stochastics cross over themselves in different directions of a long term trend than this could be an indication of an exit point or a switch in directions.
