Indicators are mathematical models that make reading price charts easier. They serve to determine the degree of volatility and identify efficient market entry/exit points. First off, I’d like to warn you that no indicators can possibly predict future price movements with 100% certainty. Still, they can be used to create trading systemswith a positive mathematical expectation.
Any indicator is based on prices. They are characterized by four key values: Open, Close, High, and Low at certain periods of time. For example, fractals are drawn across the highs of 5 price bars, so we use two price values for calculations, the high and low of a bar on a given time frame.
Indicators can be divided into several different categories, including trend indicators, oscillators, and psychological indicators.
As the name suggests, trend indicators are used to determine price direction. This type of indicators includes:
- Moving Averages;
- Bollinger Bands.
Oscillators are useful for predicting trend changes. In most cases, a trend reversal occurs after a divergence. To see whether a divergence took place, we should compare and analyze the price chart and oscillator readings. The most popular oscillators are
- Stochastic Oscillator;
- Awesome Oscillator;
Psychological indicators help traders determine market sentiment. A good example of a psychological indicator is SEFC-Bull-Bear.
To filter signals, traders usually use several indicators at the same time. The key point here is not to overplay it as some users apply so many indicators at once that they cannot see the price chart behind them.
Others put too much effort into filtering and wait for a good trading setup forever.
A balanced and reasonable approach is key here. Before you use a new indicator on a live account, try it out on a demo account or at least watch it live. Keep in mind that some indicators only show excellent results when they are backtested.