20 Technical Analysis Indicators and Oscillators
There are two principles of analysis used to forecast price movements in the financial markets — fundamental analysis and technical analysis.
Fundamental analysis depending on the market being analyzed, can deal with economic factors that focus mainly on supply and demand or valuing a company based upon its financial strength. It helps to determine what to buy or sell.
Technical Analysis :
Technical analysis is the study of market action through the use of charts to forecast future trends. Technical analysis helps to determine when to buy and sell.
Technical analysis has been used for hundreds of years. It can be applied to any market, an advantage over fundamental analysis. Technicians believe that the study of market action will tell all and that each and every fundamental aspect will be revealed through the actions of investors entering or exiting positions. Market action includes many sources of information — price, volume, open interest, and volatility.
Technical analysis is based upon three main premises;
1) Market action discounts everything
2) Prices move in trends
3) History repeats itself
Technical analysis has been proven to be an effective tool for investors and is constantly becoming more accepted by market participants. When used in conjunction with fundamental analysis, technical analysis can offer a more complete valuation, which can make the difference in executing profitable trades.
3 mainly reasons to study the Indicators and Oscillators:
Indicators and Oscillators can help the traders to determine if the currency pair or stock is in an Overbought or Oversold territory and are a very good warning signals.
The direction of the Indicators and Oscillators can help the traders to confirm the old Trend or to predict a new Trend.
Positive signal: In case of Indicators and Oscillators are going up.
Negative signal : In case of Indicators and Oscillators are going down.
Warning signal : In case of Indicators and Oscillators are going against a moving average.
Positive signal: In case of the price of a currency pair or stock is making new lows and Indicators and Oscillators are not (warning: it’s time to buy).
Negative signal : In case of the price of a currency pair or stock is making new highs and Indicators and Oscillators are not(warning: it’s time to sell).
Indicators and Oscillators are diveded in two broad categories:
- A) Trend Indicators
- B) Momentum Oscillators
A) ‘ Trend Indicators’
Statistics used to measure current conditions as well as to forecast financial or economic trends. Indicators are used extensively in technical analysis to predict changes in stock trends or price patterns. The most famous Trend Indicators are the Moving Averages, MACD and Bollinger Bands.
1) Moving Averages
A widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random price fluctuations. A moving average (MA) is a trend-following or lagging indicator because it is based on past prices. The two basic and commonly used MAs are the simple moving average (SMA), which is the simple average of a security over a defined number of time periods, and the exponential moving average (EMA), which gives bigger weight to more recent prices. The most common applications of MAs are to identify the trend direction and to determine support and resistance levels.
The duration of a moving average must be determined according to the length of the market cycle that you are tracking, for example 50 or 100 periods for long-term cycles and less than 25 for short cycles. Unfortunately, due to the delay between the evolution of the moving average and that of current prices, it is hard to find a moving average that makes you win consistently. Most traders will experiment with different time periods in their moving averages so that they can find the one that works best for this specific task.
Figure 1: Sell and Buy signals by using the Moving Average
Figure 1 indicates perfectly the scenario when the price of the NZD/USD pair is above the moving average (Moving Average of the last 30 periods)indicates an upward trend (buy signal) and below it is a falling trend (sell signal) . If the market doesn’t express any definite tendancy, the price will vary above it and below it. Whenever prices cross the moving average, it can be an indicator that it’s a good time to buy or sell as shown in our example.
Figure 2: Sell and Buy signals by using 2 Moving Averages
By using two moving averages, a short one (MM10) and a long one (MM25), it is possible to spot changes in trends and therefore to generate buying or selling signals as we can see from Figure 2 . The upward momentum is confirmed with a bullish crossover, which occurs when the short-term MA crosses above a longer-term MA. Downward momentum is confirmed with a bearish crossover, which occurs when a short-term MA crosses below a longer-term MA. Finally, notice how the price of the asset finds support at the moving average when the trend is up, and how it acts as resistance when the trend is down.
As noted earlier, MAs lag current price action because they are based on past prices; the longer the time period for the MA, the greater the lag. Thus a 200-day MA will have a much greater degree of lag than a 20-day MA because it contains prices for the past 200 days. The length of the MA to use depends on the trading objectives, with shorter MAs used for short-term trading and longer-term MAs more suited for long-term investors. The 200-day MA is widely followed by investors and traders, with breaks above and below this moving average considered to be important trading signals.
While MAs are useful enough on their own, they also form the basis for other indicators such as the Moving Average Convergence Divergence (MACD).
2) ‘Moving Average Convergence Divergence – MACD’
A trend-following momentum indicator that shows the relationship between two moving averages of prices. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the “signal line”, is then plotted on top of the MACD, functioning as a trigger for buy and sell signals. The further the MACD moves away from its signal line and the zero line, the stronger the price trend is.
There are three common methods used to interpret the MACD:
- Crossovers – As shown in Figure 1 below, when the MACD falls below the signal line, it is a bearish signal, which indicates that it may be time to sell. Conversely, when the MACD rises above the signal line, the indicator gives a bullish signal, which suggests that the price of the asset is likely to experience upward momentum. Many traders wait for a confirmed cross above the signal line before entering into a position to avoid getting getting “faked out” or entering into a position too early, as shown by the first arrow.
- Divergence – When the security price diverges from the MACD. It signals the end of the current trend.
- Dramatic rise – When the MACD rises dramatically – that is, the shorter moving average pulls away from the longer-term moving average – it is a signal that the security is overbought and will soon return to normal levels.
Figure 1: Sell and Buy signals using the MACD
3) ‘Bollinger Bands’
A band plotted two standard deviations away from a simple moving average, developed by famous technical trader John Bollinger.
Bollinger Bands keep the evolution of prices within an envelope which simultaneously acts as support, resistance as well as trend and volatility indicators.The standard deviation in Bollinger Bands is calculated according to the market’s volatility. The more volatile prices are, the further apart the bands are. According to John Bollinger, this system shouldn’t be used by itself. It should be combined with other technical indicators.
– A basic 20-day moving average
– Upper band = 20-day moving average + 2 standard deviations of average prices over 20 days
– Lower band = 20-day moving average – 2 standard deviations of average prices over 20 days
Identifying a change in the trend
Price changes tend to occur after a tightening of the bands.
Figure 1: Sell signal using Bollinger Bands
According to Figure 1, the price changed when the Bollinger Bands tighten at most in the middle of the chart.
Measuring the strength of a trend
The greater the spread between the lower and upper bands, the stronger the trend. Prices that go beyond the bands are a strong signal that the trend will continue as can be seen in Figure 2.
Figure 2: Buy signal using the Bollinger Bands
Playing on bounces between bands
The bands can be used as support and resistance levels as can be seen in Figure 3. After having touched a band, prices have a tendency to want to touch the opposite band. This technique can be very useful in a market with no clear tendency or when the bands are parallel.
Figure 3: Support and Resistance levels using Bollinger Bands
4 &5 ) ‘The Directional Movement Index (DMI) and the Average Directional Movement Index(ADX)‘
Three lines compose the Directional Movement Indicators (DMI): ADX, DI+ and DI-. The Average Directional Index (ADX) line shows the strength of the trend. The higher the ADX value, the stronger the trend. The Plus Direction Indicator (DI+) and Minus Direction Indicator (DI-) show the current price direction. When the DI+ is above DI-, current price momentum is up. When the DI- is above DI+, current price momentum is down.
The DMI (Directional Movement Index), created by J. W. Wilder, allows traders to compare buy and sell pressure. When used along with the ADX (Average Directional Movement Index), it measures the force and strength of the market’s direction. This system is mainly used for short-term trading. The default sample used for this indicator is 14 days.
The ADX line allows you to evaluate the strength of a trend. When the indicator is above 25, the market is following a definite trend. On the other hand, when the indicator is below 25, the market is evolving with no genuine direction.
The ADX line can be used as a complement to systems that track trends relatively well, such as moving averages. It will indicate whether the market is sufficiently directional for a trader to follow signals given by the moving averages.If the ADX value is low, it can be used with powerful trading range systems such as the stochastic indicator.
The DI+ and DI- lines display the market’s buy and sell pressure. By analysing how each of these two lines are positioned with respect to each other, you can see whether the market is dominated by buyers or sellers.The further apart the DI+ and DI- curves are from each other, the more we consider that the price trend is becoming stronger. On the other hand, when the curves get close or cross each other, it becomes likely that the price trend will reverse.
Buy or sell signals can be determined easily when the DI+ and DI- lines cross each other. This signal will be stronger if the ADX has a high value.
Figure 1: Sell and Buy signals using ADX, DI- and DI+
In our example in Figure 1, we can see the sell signal when the DI- crossed DI+ in the first half of the chart and remain above it until the end.Meanwhile, the ADX is high enough (more than 25 ) to strongly confirm the downtrend movement of the price.
6) ‘Pivot Point’
A technical analysis indicator used to determine the overall trend of the market over different time frames. The pivot point itself is simply the average of the high, low and closing prices from the previous trading day. On the subsequent day, trading above the pivot point is thought to indicate ongoing bullish sentiment, while trading below the pivot point indicates bearish sentiment.
The formulas behind Pivot Levels are the followings:
Resistance 3 = High + 2*(Pivot – Low)
Resistance 2 = Pivot + (R1 – S1)
Resistance 1 = 2 * Pivot – Low
Pivot Point = ( High + Close + Low )/3
Support 1 = 2 * Pivot – High
Support 2 = Pivot – (R1 – S1)
Support 3 = Low – 2*(High – Pivot)
As you can see from the above formulas, just by having the previous day’s high, low and close prices, you eventually end up with 7 points: 3 resistance levels, 3 support levels and the actual pivot point. If the market opens above the pivot point, then the bias for the day is long trades. If the market opens below the pivot point, then the bias for the day is short trades. The three most important pivot points are R1, S1 and the actual pivot point. The general idea behind trading pivot points is to look for a reversal or break of R1 or S1. By the time the market reaches R2 or R3, or S2 or S3, the market will already be overbought or oversold and these levels should be used as cues to exit rather than enter.
A perfect setup would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of your position. Because many traders follow pivot points, you will often find that the market reacts at these levels. This gives you an opportunity to trade.
Figure 1 : Supports and Resistances levels using Pivot Points
Using Figure 1 example, we can observe the price movements between the most important levels, R1 and S1. Therefore these 2 levels are very strong support and resistance levels and excellent trading indicators.
7) ‘Parabolic SAR’
The parabolic SAR is a technical indicator also known as the “stop and reversal system and is a trend indicator, used by many traders to determine the direction of an momentum and the point in time when this momentum has a higher-than-normal probability of switching directions. Parabolic tells traders about price stop-and-reverse points as well as trend direction.
Its concept of usage is easy to understand from the first look. Parabolic SAR appears as a series of dots placed either above or below price on a chart, where each dot represents certain time period.
One of the most important aspects to keep in mind is that the positioning of the “dots” is used by traders to generate transaction signals depending on where the dot is placed relative to the asset’s price. A dot placed below the price signals, traders to expect the momentum to remain in the upward direction. A dot placed above alerts traders that the bears are in control and that the momentum is likely to remain downward.
The step sets sensitivity of Parabolic SAR indicator. If the Step is too high, Parabolic SAR becomes more sensitive and will flip back and forth more often, with lower step Parabolic SAR will become smoother(see also Oscillator Indicators). Maximum step sets a cushion between price and Parabolic SAR. The higher the max step the closer the trailing stop will be to the price.
Figure 1: Parabolic SAR indicator signals entry and exit strategies
In Figure 1, Parabolic SAR indicator signals very clear some entry and exit levels. You can notice how perfectly the dots follow the trend directions and indicate the price reversals of the asset.
8) ‘Ichimoku Kinko Hyo’
A technical indicator that is used to gauge momentum along with future areas of support and resistance. The Ichimoku indicator is comprised of five lines called the tenkan-sen, kijun-sen, senkou span A, senkou span B and chickou span. This indicator was developed so that a trader can gauge an asset’s trend, momentum and support and resistance points without the need of any other technical indicator.
“Ichimoku” is a Japanese word that means “one look.” This charting technique was created by a Japanese newspaper writer. It does look very complicated when a trader sees the indicator for the first time, but don’t hesitate to give this indicator a try because the complexity quickly disappears once you gain an understanding of what the various lines mean and why they are used.
Essentially made up of four major components, the application offers the trader key insight into FX market price action. First, we’ll take a look at both the Tenkan and Kijun Sens. Used as a moving average crossover, both lines are simple translations of the 20- and 50-day moving averages, although with slightly different time frames.
- The Tenkan Sen – Calculated as the sum of the highest high and the lowest low divided by two. The Tenkan is calculated over the previous seven to eight time periods.
- The Kijun Sen – Calculated as the sum of the highest high and the lowest low divided by two. Although the calculation is similar, the Kijun takes the past 22 time periods into account.What the trader will want to do here is use the crossover to initiate the position – this is similar to a moving average crossover.
Figure 1: A crossover in similar Western branded fashion
Looking at the Figure 1 example, we see a clear crossover of the Tenkan Sen (black line) and the Kijun Sen (red line) at point X. This decline simply means that near-term prices are dipping below the longer term price trend, signaling a downtrending move lower.
Now let’s take a look at the most important component, the Ichimoku “cloud”, which represents current and historical price action. It behaves in much the same way as simple support and resistance by creating formative barriers. The last two components of the Ichimoku application are:
- Senkou Span A – The sum of the Tenkan Sen and the Kijun Sen divided by two. The calculation is then plotted 26 time periods ahead of the current price action.
- Senkou Span B – The sum of the highest high and the lowest low divided by two. This calculation is taken over the past 52 time periods and is plotted 26 periods ahead.
Once plotted on the chart, the area between the two lines is referred to as the Kumo, or cloud. Comparatively thicker than your run-of-the-mill support and resistance lines, the cloud offers the trader a thorough filter. Instead of giving the trader a visually thin price level for support and resistance, the thicker cloud will tend to take the volatility of the currency markets into account. A break through the cloud and a subsequent move above or below it will suggest a better and more probable trade. Let’s take a look Figure 2’s comparison.
Taking our USD/CAD example , we see a comparable difference between the two. Although we see a clear support at 1.1522 in our more standard chart (Figure 2), we subsequently see a retest of the level. At this point, some trades probably will be stopped out as the price action comes back against the level, which is somewhat concerning for even the most advanced trader. However, in our Ichimoku example (Figure 3), the cloud serves as an excellent filter. Taking the volatility and apparent take back into account, the cloud suggests a better trade opportunity on a break of the 1.1450 figure. Here, the price action does not trade back, keeping the trade in the overall downtrend momentum.
Figure 2 : Classic support and resistance break
Figure 3: Ichimoku creates a better break opportunity
- Chikou Span. Seen as simple market sentiment, the Chikou is calculated using the most recent closing price and is plotted 22 periods behind the price action. This feature suggests the market’s sentiment by showing the prevailing trend as it relates to current price momentum. The interpretation is simple: as sellers dominate the market, the Chikou span will hover below the price trend while the opposite occurs on the buy side. When a pair remains bid in the market or is bought up, the span will rise and hover above the price action.
Figure 4: Chikou helps to sort out market sentiment
Putting It All Together
Like everything else, there’s no better substitute for learning but through application. Let’s break down the best method of trading the Ichimoku cloud technique.
Figure 5: Lines that tell a complete story
Trading The Cloud:
Taking our U.S. dollar/Japanese yen example in Figure 4, we’ll zoom in on a more recent scenario in Figure 5. With the currency pair fluctuating in a range between 116 and 119 figures for the beginning of the year, traders were anxious to see a break out of the persistent range. Here, the cloud is a product of the range-bound scenario over the first four months and stands as a significant support/resistance barrier. With that established, we look to the Tenkan and Kijun Sen. As mentioned before, these two act as a moving average crossover with the Tenkan representing a more short-term moving average and the Kijun acting as the base line. As a result, the Tenkan dips below the Kijun, signaling a decline in price action. However, with the crossover occurring within the cloud at Point A in Figure 5, the signal remains unclear and will need to be clear of the cloud before an entry can be considered. We can also confirm the bearish sentiment through the Chikou Span, which at this point remains below the price action. Conversely, if the Chikou was above the price action, it would confirm bullish sentiment. Putting it all together, we are now looking for a short position in our U.S. dollar/Japanese yen currency pair.
Figure 6: Place the entry ever so slightly in the cloud barrier
Because we are equating the cloud to a support/resistance barrier, we will want to see a close of the session below the cloud before initiating any type of short sell position. As a result, we will be entering at Point B on our chart. Here, we have a confirmed break of the cloud as the price action stalls on a support level at 114.56. The trader, at this point, can opt to place the entry at the support figure of 114.56 or place the order one point below the low of the session. Placing the order one point below would act as confirmation that the momentum is still in place for another move lower. Subsequently, we place the stop just above the high of the candle within the cloud formation. In this example, it would be at Point C or 116.65. The price action should not trade above this price if the momentum remains. Therefore, we have an entry at 114.22 and a corresponding stop at 116.65, leaving our risk out at 243 pips. In keeping with sound money management, the trade will have to have a minimum of a 1:1 risk/reward ratio with a preferable 2:1 risk/reward for legitimate opportunities. In our example, we will maintain a 2:1 risk/reward ratio as the price moves lower to hit a low of 108.96 before pulling back. This equates to roughly 500 pips and a 2:1 risk to reward – a profitable opportunity. One key note to remember: notice how the Ichimoku is applied to longer time frames, in this instance the daily. With the volatility in shorter time frames, the application will tend not to work as well as with many technical indicators.
- Refer To The Kijun / Tenkan Cross – The potential crossover in both lines will act in similar fashion to the more recognized moving average crossover. This technical occurrence is great for isolating moves in the price action.
- Confirm Down / Uptrend With Chikou – Confirming that the market sentiment is in line with the crossover will increase the probability of the trade as it acts in similar fashion with a momentum oscillator.
- Price Action Should Break Through The Cloud – The impending down/uptrend should make a clear break through of the cloud of resistance/support. This decision will increase the probability of the trade working in the trader’s favor.
- Follow Money Management When Placing Entries – By adhering to strict money management rules, the trader will be able to balance risk/reward ratios and control the position.
A technical analysis tool that is banded between two extreme values and built with the results from a trend indicator for discovering short-term overbought or oversold conditions. As the value of the oscillator approaches the upper extreme value the asset is deemed to be overbought, and as it approaches the lower extreme it is deemed to be oversold.
Oscillators are most advantageous when a clear trend cannot be easily seen in a company’s stock such as when it trades horizontally or sideways.
The term “Momentum” refers to the velocity of a price trend and measures whether a rising trend is accelerating or decelerating or whether prices are declining at a faster or slower pace.
The most common oscillators are: the RSI, Stochastic oscillator, ROC and CCI.
9) ‘Relative Strength Index – RSI’
RSI is a momentum oscillator that measures the velocity and magnitude of price movements. The RSI Indicator is a a good tool to help identify overbought and oversold conditions, divergences, and crossovers that investors use to identify new trends in a stock or the market.
Like most indicators there are two general ways in which the indicator is used to generate signals – crossovers and divergence. In the case of the RSI, the indicator uses crossovers of its overbought, oversold and center line.
An RSI below 30 indicates an oversold condition, acting as a warning to the investor to be ready to buy the best set ups. As the RSI indicator rises through 30, it gives a buy signal. This is especially true if the long-term trend is up, as the RSI rises through 30, creating potential entry points.
The most often used observation period is 14 days, a shorter period will generate a high number of false signals. It is calculated using the following formula:
RSI = 100 – 100/(1 + RS*)
*Where RS = Average of x days’ up closes / Average of x days’ down closes.
Figure 1: Overbought and Oversold zones
As you can see from our example in Figure 1, the RSI ranges from 0 to 100. An asset is deemed to be overbought once the RSI approaches the 70 level, meaning that it may be getting overvalued and is a good candidate for a pullback. Likewise, if the RSI approaches 30, it is an indication that the asset may be getting oversold and therefore likely to become undervalued.
Figure 2: Usage of RSI in Market Divergences
Figure 2 illustrates perfectly a Negative Divergence signal where the price of the currency pair is making new highs and the RSI not. Therefore it appeared a nice Sell Signal when the RSI made a failure approach of the 70 level again).
10) ‘Stochastic Oscillator’
A technical momentum indicator that compares a security’s closing price to its price range over a given time period. As with the RSI, it allows investors to visualise with graphs the oversold and overbought zones.
This indicator is highly volatile, therefore it is recommended that you use it with other Oscillators such as the RSI or the MACD . The slow stochastic oscillator is frequently used since it is less volatile and therefore gives off less false signals.The oscillator’s sensitivity to market movements can be reduced by adjusting the time period or by taking a moving average of the result.
Figure 1: Overbought and Oversold zones
Figure 1 illustrates that if the stochastic oscillator is below 20, the cross is consider to be Oversold and its a Buy signal for the investor. The exactly opposite happens when the stochastic oscillator is above 80, the cross is consider to be Overbought and its a Sell signal.
Figure 2: Usage of Stochastic Oscillator in Market Divergences
As we can see from Figure 2, we can identify two Market Divergences when the stochastic oscillator moves in the opposite direction than the share price. This signal indicates an upcoming shift in the market.
11) ‘Commodity Channel Index – CCI’
The Commodity Channel Index (CCI) is a shifty indicator that can be used to identify a new trend or warn of extreme conditions. CCI measures the current price level relative to an average price level over a given period of time. CCI is relatively high when prices are far above their average and relatively low when prices are far below their average. CCI can be used to identify periods where price is overbought and oversold – where the price is far from the Moving Average.
The CCI typically oscillates above and below a zero line. Normal oscillations will occur within the range of +100 and -100. Readings above +100 imply an overbought condition, while readings below -100 imply an oversold condition. As with other overbought/oversold indicators, this means that there is a large probability that the price will correct to more representative levels.
Figure 1: Sell Signal
Figure 2: Buy Signal
Figure 1 and 2 illustrate Sell and Buy Signals respectively in the market using the Commodity Channel Index (CCI) oscillator. In Figure 1, every time CCI is crossing +100 is entering in the overbought zone signaling sell pressure. In addition, in Figure 2, every time CCI is crossing -100 is entering in the oversold zone signaling buy pressure.
12) ‘Momentum Oscillators’
Momentum is the changing velocity of a price when related to security analysis. Momentum indicators are designed to track momentum in the price of a tradable to help identify the relative enthusiasm of buyers and sellers involved in the price trend development. Usually, the momentum indicator compares the most recent closing price to a previous closing price, but it can also be used on other indicators such as moving averages.
The momentum indicator is usually displayed as a single line. The indicator measures overbought and oversold market conditions. It’s usually plotted on a chart using negative numbers with a scale ranging from +100 and -100.
Figure 1: Overbought and Oversold Signals
Figure 1 illustrates the Momentum overbought and oversold signals. When the Momentum crossed +100 it generated Sell signals and when it reached the -100 level it generated bullish signals to the investors.
13) ‘Price Rate Of Change – ROC’
The Rate of Change (ROC) indicator calculates how price has changed within a specified number of time periods by calculating the difference between the current bar’s price and the price a selected number of bars ago. The difference is calculated in “Points” or as a “Percentage”. The ROC moves in a wave-like fashion (similar to that of price), but it oscillates above and below an equilibrium level set at zero. The ROC rises as prices rise; the ROC declines as prices decline. The greater the change in prices, the greater the change in the ROC indicator.
The ROC indicator is a simple indicator capable of producing a myriad of buy and sell signals. However, there are four basic methods of interpreting the ROC indicator:
1) Zero-Level Crossovers: A buy signal occurs when the ROC crosses above zero and a sell signal occurs when the ROC crosses below zero.
2) Overbought and Oversold zone: The higher the ROC readings the more overbought a trading instrument is and the lower the ROC readings the more oversold a trading instrument is.
3)Trend Line Breakouts: Trend lines can be drawn connecting the peaks and troughs of the ROC indicator. Often ROC begins to turn before price thereby making it a leading indicator.
4) Divergence: Trade long on Classic Bullish Divergence: Lower lows in price and higher lows in the ROC; Trade short on Classic Bearish Divergence: Higher highs in price and lower highs in the ROC.
Figure 1: Buy and Sell Signals
Figure 1 shows the buying signals when ROC crossed twice the zero line and the sell signals when ROC reached again twice the overbought levels in our example.
Leonardo Fibonacci was an Italian mathematician born in the 12th century. He is known to have discovered the “Fibonacci numbers,” which are a sequence of numbers where each successive number is the sum of the two previous numbers.
e.g. 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.
These numbers possess a number of interrelationships, such as the fact that any given number is approximately 1.618 times the preceding number.
There is a special ratio that can be used to describe the proportions of everything from nature’s smallest building blocks, such as atoms, to the most advanced patterns in the universe, such as unimaginably large celestial bodies. Nature relies on this innate proportion to maintain balance, but the financial markets also seem to conform to this golden ratio.
Interpretation of the Fibonacci numbers in technical analysis anticipates changes in trends as prices tend to be near lines created by the Fibonacci studies. The four popular Fibonacci studies are arcs, fans, retracements, and time zones.
This graphic indicator is useful for establishing support and resistance zones within a defined period (with the help of two points).After a significant movement (upward or downward), prices will often bounce and retrace a portion of their original movement close to the Fibonacci retracement levels.
Fibonacci retracements are displayed by drawing a tendency line between two extreme points. A series of horizontal lines will then appear (0.0%, 23.6%, 38.2%, 50.0%, 61.8%, 100%, 138.2%, 161.8%) which represent the percentage of corrections that you can look out for.
14) Uptrend Fibonacci Retracement:
Draw the tendency line between the Lower point until the Higher point of a significant upward movement of the currency and mark all the Fibo levels as possible support levels for the currency may hit before returning to the uptrend direction.
Figure 1: Uptrend Fibonacci Retracement
In Figure 1 the price correction of the uptrend movement reached the 38.2% of the Fibonacci Retracement level before return to the major uptrend direction.
15) Downtrend Fibonacci Retracement:
Draw the tendency line between the higher point until the Higher point of a significant downward movement of the currency and mark all the Fibo levels as possible Resistance levels for the currency may hit before returning to the downtrend direction.
Figure 2: Downtrend Fibonacci Retracement
In Figure 2 the price correction of the downtrend movement found resistance mainly on the 61.8% Fibonacci Retracement Level and ended on the 100% resistance level.
16) ‘Fibonacci Extensions’
Fibonacci extensions are simply ratio-derived extensions beyond the standard 100% Fibonacci retracement level. They are popular as forecasting tools, and they are often used in combination with other technical chart patterns.
Figure 1: Fibonacci extension forecast:
In our example in Figure 1 can be seen the Fibonacci extension levels of 161.8% and 261.8% act as future areas of support and resistance. Here we can see that the original points (0-100%) were used to forecast extensions at 161.8% and 261.8%, which served as support and resistance levels in the future.
Fibonacci extensions are also commonly used with other chart patterns such as the ascending triangle. Once the pattern is identified, a forecast can be created by adding 61.8% of the distance between the upper resistance and the base of the triangle to the entry price. As shown in Figure 2 below, these levels are generally used as strategic places for traders to consider taking profits.
Figure 2: Many traders use the 161.8% Fibonacci extension level as a price target for when a security breaks out of an identified chart pattern.
17) Fibonacci Channels
The Fibonacci pattern can be applied to channels not only vertically, but also diagonally, as shown in Figure 1.
Figure 1 : Fibonacci retracement when used in combination with Fibonacci channels can give a trader extra confirmation that a certain price level will act as support or resistance.
By combining indicators and chart patterns with the many Fibonacci tools available, you can increase your chances of a successful trade. Remember, there is no one indicator that predicts everything perfectly (if there were, we’d all be rich). However, when many indicators are pointing in the same direction, you can get a pretty good idea of where the price is going.
18) ‘Williams %R’
Developed by Larry Williams, the Williams %R (pronounced “percent R”) indicator is a momemtum oscillator used to measure overbought and oversold levels. It’s very similar to the Stochastic Oscillator except that the %R is plotted on a negative scale from 0 to -100 and has no internal smoothing. The %R defines the relationship of the close price relative to the High-Low range over n-Periods. The nearer the close price is to the highest high of the range the nearer to zero the reading will be. Alternatively, the nearer the close price is to the lowest low of the range the nearer to -100 the reading will be. If the close price equals the highest high of the range the reading will be 0; if the close price equals the lowest low of the range to reading will be -100.
As an overbought/oversold indicator, Williams %R values from 0 to -20 are considered overbought while values from -80 to -100 are considered oversold. An interesting phenomena of the %R indicator is its uncanny ability to anticipate a reversal in the underlying trading instrument’s price.
Figure 1 illustrates the buying signals from the Williams %R oscillator every time is reaching the oversold zone from -80 to -100 and the selling signals every time is reaching the overbought zone from -20 to 0.
Volume Based Indicators
The number of shares or contracts traded in a security or an entire market during a given period of time. It is simply the amount of shares that trade hands from sellers to buyers as a measure of activity. If a buyer of a stock purchases 100 shares from a seller, then the volume for that period increases by 100 shares based on that transaction.
Figure 1: Higher Volume in a Bullish Breakout
Volume is an important indicator in technical analysis as it is used to measure the worth of a market move. If the markets have made strong price move either up or down the perceived strength of that move depends on the volume for that period. The higher the volume during that price move the more significant the move as it can be seen in Figure 1.
20) ‘Accumulation/Distribution (AD)’
A volume indicator which tries to gauge supply and demand for a currency pair by discovering if investors are generally “Accumulating” (buying) or “Distributing” (selling) the pair. The basic premise has always been that volume (or money flow) may be a leading indicator to price action. This indicator is a variant of the more commonly used indicator On Balance Volume. They are both used to confirm price changes by looking at whether there is more volume on buying or selling sessions.
The indicator is primarily used to confirm price trends, or spot potential trend changes in price based on divergence with the Accumulation/Distribution line. The indicator looks at each period individually, and whether the price closes in the upper or lower portion of the period’s (day’s) range. This means not all divergences will result in a price trend reversal. Occasionally anomalies will occur where the price is trending lower (higher) but the indicator is rising (falling), because even though the price trend is down, each day the price is finishing in the upper portion of its daily range. High volume days can accentuate this characteristic.
Figure 1: Negative Divergence using AD
In Figure 1 is shown the price o Apple stock reaching the higher level of $560 and the same time the Accm/Dist indicator is going down. This movement indicates price weakness and possible negative divergence because the stock was going up without strong volumes.