understand the use of technical indicator to create profit in the share market

Isn’t the share market a mysterious entity in India even years after its inception in the country?

A wide array of terminologies are thrown your way when you attempt to understand the Share Market in India.

One such vital term is Technical Analysis.

Along with that we are also introduced to a certain set of tools called “technical indicators” which seem to be quite important!

Technical Analysis provides the overview of financial stock price movements which may happen in the future, based on the study of previous past price movements.

It is believed that Charles Dow, the father of Dow Theory in Trading, initiated the study of stock charts by following past trends in the market.

His Dow Theory talks about technical analysis as well.

The general theory among technical analysts who are also known as “chartists” or “technicians,” is that future price movements in a stock can be predicted from a study of previous prices and volume data.

These predictions may not always be precise but they would help traders understand which way the stock prices might move.

This anticipatory power would help the traders know where to invest and when to sell or buy a stock.

Technical stock analysts are only interested in the price movements as experienced in the stock market.

While other approaches in trading attempt to develop ideas that lead to actions, technical analysts focus on actions that might lead to further actions.

Technical Trading deals with the buying or selling of stocks, commodities or any tradable instrument where the price of the tradable instrument is influenced by the outcome of supply and demand.

Monitoring investors’ sentiments also becomes a pivotal factor of focus in technical trading.

But in first part of this article, we provide an insight into what technical trading really is, how it works and what tips important figures of stock market trading have provided for technical trading.

Technical Trading and Technical Analysis are terminologies which often overlap, during the understanding of stock market trading.

Technical Analysis can predict both short-term and long-term trends.

So, we see how understanding the benefits and limitations of technical analysis helps us identify a new set of trading skills that will make you a more successful stock trader.

We are well aware that all traders wish to make the most of their trading skills.

When one invests in a stock or a ‘tradable’ commodity, they are aware of the risks they might have to undertake.

Trading is thus, not just an investment of money but also an investment of precious time and mental wealth.

To make this an easy task, one must know the initial rules to be followed before beginning to indulge in e-trade.

Let us begin with the most important five pointers which could help you while dealing with Technical Analysis in trading –

Charts

Technical Analysis is often graphically represented and it focuses on the movements of stock/trade instrument price.

Share Market Technical Analysis is based on 3 assumptions - history, price of stock and market discounts

Technical analysis is based on the following three assumptions – history tends to repeat itself, price of stocks always move in trends and that the market discounts everything.

Along with all this, one must remember that learning about the “Trends” forms the most important part of understanding Technical Analysis.

There are two types of ‘Trends’ you may have to deal with in stock trading – Uptrend and Downtrend.

Further more, these trends can be of three lengths – short term trend, long term trend and Intermediate trend.

It is very important to know the signs which would help one map the current market trend.

There are several indicators used by traders like the Average Directional Movement Index (ADX) line, which helps to determine whether the market is in a trending or a trading phase.

One must remember that major trend lines show the longer trend while minor trend lines show the shorter trend.

While reading a trade chart, if one notices that triangles on the chart are usually broken on the flat side, it is an indication that an ascending triangle is usually broken marking an upside breakout, while a descending one is usually broken to the downside.

In such cases, trade chartists must look for other hints to determine if a triangle signals accumulation or distribution.

While analyzing a trade graph, it is important to remember that the broader the market, the stronger it is.

A show of narrow breadth indicates limited participation and in such cases the chances of failure are above average.

Directions

Direction is a very important factor in technical analysis.

A long sideways concentration after an advance shows signs of future resistance.

In such cases, it would be advisable to expect resistance or a bearish reversal when prices go down and return to the previous level.

A long sideways concentration after a descent shows relative support in the future and in such cases it would be advisable to expect support or a bullish reversal as the prices go up and then return to this level.

At the same time, when a crowd of traders are proven right during a particular market trend, excessive sentiments towards one direction or another can delay a movement in price.

Volume and Gaps

Always look for a volume pitch that could signal the end of a long move.

An extended move could indicate a volume surge which would end in a fizzle while an extended descent could indicate a volume surge creating a selling pitch.

It is important to remember that during an advance in stock movement, begin or add to long positions after a one day decline, more so when the decline is on lower volume.

During a decline, begin or add to shorter positions after a one-day advance, more so if the bounce is on lower volume.

Understanding functions of gaps is very important.

understanding three important GAPS and their functions- Breakaway gaps, exhaustion gaps, Continuation gaps

Breakaway gaps could mark the beginning of a new trend and are illustrated by gaps that are not filled.

Continuation gaps could mark a continuation of the existing trend while exhaustion gaps mark a trend reversal and are illustrated through gaps that are filled.

Average

Moving averages throw better light on buy and sell signals.

They tell you if the existing trend is still viable and they help in confirming trend changes.

Nonetheless, moving averages do not help in forecasting approaching trend changes.

It is widely accepted that a combined chart of two moving averages is the most accurate method to find trading signals.

Speed

With the help of Elliot’s Theory in Technical Analysis, you can map the speed of a particular direction.

Elliot’s Theory is nominally based on the mathematical expression of Fibonacci Ratio.

The Elliott Wave Principle is based on the concept that in the stock market the movement of the prices is not a result media speculation but is related to the psyche of the market participants or traders.

The theory states that the unfolding of market prices in specific patterns or “waves” as traders call it today.

These are price patterns which can help a trade analyst dealing with Elliott Waves to understand whether the prices are likely to go up or down.

With the understanding of where the prices might move through the Elliott Wave cycle, traders have a unique tool at their disposal to find a low risk and high yielding entry and exit point for their trading.

While dealing with the Elliot Wave Theory in technical analysis, always remember that only in case of a positive market does a chart show 5 waves up and 3 waves down but it is highly possible that in case of a declining market, the chart might show 5 waves down and 3 waves up.

The 2nd part of this article is to help you see the pros associated with the use of Technical Indicators in the Share Market.

Most of us have heard the words and have also may be used them during our tryst with trading.

The article goes deeper into the reasons as to why as an aspiring trader or an experienced one, we must realize the usefulness associated with Technical Indicators.

As the name suggests, they form a part of the larger umbrella of trading approaches in Stock Trading – Technical Analysis.

Technical analysis is one of the most sought after trading approach today.

In spite of traders seldom believing it to be a non-scientific approach, technical analysis is still considered to be quite a popular approach amongst many.

It is mostly used for price forecasting and to fathom trend movements.

Technical analysis also provides recommendations for when to invest in the share market and when to exit it.

Technical analysis best serves its purpose due to its meticulous indicators and oscillators.

These indicators and oscillators are what help you execute your strategies.

They identify the crowd psychology through the patterns and other such graphical representations.

Technical indicators base their functioning on the logic that studying historical data is of foremost importance as they provide an insight into how the market might change in the future.

Keeping this logic in mind, how many new-age investors believe in this logic is debatable.

Nonetheless, hardly any traders would be of the opinion that the technical indicator has proven to be quite a helpful tool.

There are several technical indicators available to traders today – some useful only to seasoned traders while others can be used by beginners as well.

This differentiation is mainly due to the fact that the functioning of each of these technical indicators are rooted in their mathematical framework – each of them follow a specific pattern of usage and it is important to research on them before using them.

There are some technical indicators which are easy to use and do not come bearing several complex mathematical technicalities.

These indicators are also used for charting, pattern-reading and many such graphical representations.

Nevertheless, let’s look at some of these technical indicators and oscillators that have proven to be quite helpful to traders around the world:-

  • Average Directional Index (ADI)
  • Accumulation/Distribution Line
  • Aroon
  • Aroon Oscillator
  • Moving Average Convergence (MACD)
  • Relative Strength Index
  • On-balance volume
  • Stochastic Oscillator
  • Stochastic Indicator
  • Bollinger Bands
  • Eliott’s Waves

Now, why must you invest using these indicators?

Through the course of this write up, we will tell you how to use these technical indicators to stand out in the art of stock market trading!

Trading is by itself a difficult task which requires a lot of learning – so this post will provides you with a list of reasons as to why the use of technical indicators makes your trading experience a lot smoother.

So, below is a list of 12 pointers to invest using technical indicators:-

(1) With the Accumulation/Distribution Line, you can measure the ratio of buying to selling by differentiating the price movement of a period along with the volume of the same period.

This also means that the indicator is used to find out whether the money is flowing into or out of the commodity you are trading with!

This indicator also provides an insight on the quantity of purchasing as compared to the selling of a financial instrument.

(2) Technical indicators like the MACD helps to calculate the comparative difference between two moving average of the prices.

An important technical indicator – MACD (Moving Average Convergence). Buy when MACD slopes upward and Sell when MACD slopes downward

It also measures the momentum of the price movement and signals the current direction of the momentum by measuring the difference between the short-term and the long-term momentums.

(3) Technical indicators also signal overbought and oversold conditions in any financial instrument (security).

This feature also helps to know whether the price of a stock has been pushed to current levels beyond extremities and whether there is a chance for a reversal in price.

The RSI indicator is best used for these purposes.

(4) There are several volume indicators amongst the technical indicators available to traders today.

These volume indicators help to find out the movements in volume.

(5) Technical indicators like Stochastic Oscillators are used for calculating momentum but along with this feature they also show the uptrend, downtrend and the graphical topography of price movements in the market.

(6) Technical indicators like Aroon oscillators are used to forecast trend reversals in the market.

Though there are several indicators available to us today to find out about the uptrends and downtrends, it is an absolute necessity to know about when a trend might fall back in reverse.

The Aroon indicator on the other hand is used to know when a trend might begin and the magnitude of the trend is also shown along with its movements.

Aroon Oscillators – important technical indicator that helps to understand when to enter and when to exit the Indian stock market

These two indicators are a must have’s for all traders around the world!

(7) Technical indicators help in entry and exit recommendations for the stock market.

This is usually with the help of certain trend indicators and other indicators which help in reading patterns, volume, and moving averages.

It is very important for a trader to know when to enter the market and when he must exist to not incur losses.

There is a tool known as trend resistance which helps to determine the target level as well, making it easier for a trader to know about entry and exit signals.

(8) Another important feature associated with technical analysis is the study of charts.

Technical analysts are also known as chartists for their intricate use of charts and graphs. These charts contain several patterns and numerological references which require a great amount of research to be fathomed. Technical indicators like Elliott’s waves or a Gap chart, help to know about entry and exit points along with a signal for future selling of stocks.

(9) Daily Forex traders rely heavily upon the use of Technical indicators; this is majorly due to the high success rate associated with them in the area of Forex trading. They form highly meaningful signals for Forex trading.

(10) All technical indicators are based on the logic of mathematical calculations that originate from the study of past data – this is exactly the basis of technical analysis as well. Technical analysis believes that studying the historical data of stock movements which repeat themselves over the years helps to predict future stock movements.

(11) A lot of institutional investors and hedge fund managers use technical indicators to forecast stock market movements. The institutional investors use technical indicators like Ichimoku Cloud (a charting tool) which helps in figuring out the buy and sell signals. Therefore, we see how the use of technical indicators is not restricted but offers a wide purview.

(12) An indicator cannot be confused with a trading strategy – it is a tool which helps traders understand the market conditions. One of the most vital features of a technical indicator is to measure volatility of the market. Before we get down to the uses, what is volatility? Volatility refers to the amount of risk associated with the magnitude of changes in a security’s price.

Stock market volatility refers to the amount of risk associated with magnitude of changes in a security’s price

The higher the volume, the more potential it contains to spread out over larger range of values. It also indicates that the price of a security can drastically change over a period of time. The technical indicators, thus, help us understand when the changes might take place, how the prices can fluctuate and how this would affect our stocks.

These reasons can all be summed up to safely come to the conclusion that technical indicators basically forecast the stock price movements.

Along with this feature, there are several other technicalities it covers that affect the way we deal with our stocks.

Each of these indicators signals a change, a precise time to buy or sell and to know when to except losses.

These are the main things one usually seeks help for in the stock market.

The choice of indicators depends on your choice of market strategy and the approach you wish to work with.

It also depends on your style of trading and risk-tolerance.

Technical indicators take your strategy a step ahead and show you how they might pan out in the future.

This peak into the future is a necessity associated with stock market trading.

An already risk-encumbered zone to be dealing with, without helping tools like technical indicators, the stock market would seem anarchic!

The 3rd and the last part of this article deals with certain misconceptions associated with the idea of Technical Analysis and its functions.

Don’t we all fall prey to certain misconceptions and rumors doing the rounds?

To stop ourselves from making a silly mistake in the share market, let’s run through a few misconceptions concocted through the years about the functionalities of Technical Analysis.

Technical Analysis is gaining popularity in the recent years due to its quick success record.

Nonetheless, due to the innumerable terminologies and in depth understanding required for the execution of Technical Analysis, many traders around the world still hesitate to take it up.

This significant portion of people who still hesitate to take up Technical Analysis as a well accepted approach to trading, believe it to be superficial study of share market charts and patterns.

Along with people who reject the use of this approach, there are many who garner false hopes from this as well!

This post works towards eradicate any such preconceived notions you might possess towards the use of technical analysis – and, I am sure there are many!

These misconceptions stem from clouded ignorance as well as following wrong reviews.

My attempt through this post is to take you through 14 such misconceptions which surround the functionality of technical analysis.

These misconceptions are:-

Technical Analysis is best suited for short term trading or day trading

One of the most common misconceptions associated with technical analysis is that it is best suited for system based high frequency trading or day trading – mostly, trading which occurs in a short span of time.

The truth remains that technical analysis is one of the oldest trading approaches which existed long before the concept of computers became common – the only difference being, in those years, technical analysts would manually plot the graphs to fathom technical trends.

Technical Analysis is only for individual traders and not organizations

You must have heard this too many times to believe this statement is NOT true at all.

There are several investment banks and firms who swear by the use of technical analysis.

Many high frequency trading organizations and hedge funds are also known for their extensive use of technical analysis for trading purposes.

Technical Analysis provides absolutely accurate price predictions

This misconception is garnered by those who have too many expectations from technical analysis and believe it to be nothing short than a stroke of magic!

Nevertheless, sorry to break thy hearts but technical analysis does not provide an absolute price prediction – much to our dismay!

Technical analysis provides only a predictive range and not an exact number.

The profit margin should be higher in Technical Analysis

Another misconception communicated by the blind believers of Technical Analysis – this is not true either!

Though it is true that technical analysis restrains most losses, the profit margin is not abnormally high either.

Each approach provides a consistent amount of loss and gain – how wisely you apply what it offers to your trade is what makes you a clear winner!

Technical Analysis has a low success rate

Moving on from the ardent believers to the rejectors, it is often believed by many that technical analysis offers a low success rate.

While this is completely untrue, a wise use of technical analysis approach has found to have provided a higher success rate in most cases.

Technical indicators can be applied to all markets

technical indicators are not a single key for all locks. Different types of indicators are used for different type of assets class

Technical indicators or any such trading tools contain specifications.

These specifications allow them to be used for specific assets in different ways.

Equities, futures, options, commodities and bonds all function differently.

It is important to remember that technical indicators intended for the use of one asset, cannot be applied for the use of another – as both have separate rules.

Technical Analysis is a very easy and quick approach to deal with

The use of technical indicators may seem quick and painless to deal with but technical analysis as a whole is not an easy approach to learn.

There are several websites on the INTERNET who vouch to provide you with “Easy Lesson To Learn Technical Analysis in 2 days” – but they won’t take you far!

For a trading approach which contains so many intricate elements and technicalities associated with it, it would never be an idea suited for a quick grasp.

Technical Analysis works all the time

No.

Like all other approaches available to you in the trading market, technical analysis also does not arrive with a sense of omnipresence attached to it.

Technical Analysis is not considered to be suitable when a company has to report earnings of the coming week or if it has a huge lawsuit hanging over itself – these events are often termed as “fundamental events” and during such cases, technical analysis would not help much.

Technical Analysis is not applicable in today’s market due to the advance in algorithm trading

Some new age traders believe that technical analysis as an approach has lost its charm due to the advance in algorithm trading today.

These traders believe that unlike the years gone by, traders have to compete against computer signals in trading and this requires for the advanced technology associated with algorithm trading today.

While many veteran traders disagree with this logic, there is a rapid increase in the number of people who have complete faith in the function of algorithm trading.

Technical indicators like Ichimoku Cloud and Heikin Ashi are not reliable and are suited only for Asian markets

This statement is not exactly true.

Technical indicators like Ichimoku Cloud and Heikin Ashi are Asian trading tools.

They have been found to be more suited to Asian markets but that does not necessarily mean that they are completely unreliable for usage in the Western markets.

More than being indicators these are charting tools which are best suited to understand patters and chart readings.

They have proven to be useful before in other non-Asian markets as well.

Technical Analysis provides mixed signals

There are several online platforms where traders have mentioned how technical analysis provides mixed buy or sell signals.

In some cases, traders have complained about one of the technical indicators showing a buy signal while another indicator showing a sell signal.

This situation seemed to have a great deal of havoc amongst the traders involved but it is always important to remember that the functionality of each trading approach exists bearing the fact that we must be well aware of its intricacies.

Before beginning with any approach, knowing about the nature of each technical indicator and its patterns is very important as it would stop us from making mistakes as the one mentioned above.

If you know something inside-out, there’s no fooling you!

Technical Analysis provides biased signals

Most amateur traders find Technical Analysis to be a confusing domain.

This coaxes them to believe that Technical Analysis provides biased signals – meaning, one technical analyst’s opinion may contradict the others.

While this holds true, the fundamental factor governing the approach of Technical Analysis is that technical methods used by analysts vary.

Knowing this well enough, we would have the liberty to follow the analysis of the analyst whom we have known to provide precision.

Thus, there is no such bias involved in the analysis put forth.

Technical Analysis is a major investing strategy for Penny Stocks

Sorry – this is another notion you must chuck out of your mind’s window!

Technical trading is not known to work with the prediction of huge moves in penny stocks.

Fundamental analysis on the other hand is known to have quite a good record dealing with the prediction of major stock movements in penny stocks.

Using Technical Analysis alone to predict the price movement of penny stocks, is an unreliable move as technical analysis can only rarely locate the movement of a penny stock.

Technical Analysis is based on the rule that studying historical data of price movements always help to fathom future prices

stock technical analysis - one can predict the price movements of stocks from the past data but there is no guarantee for this prediction

Again, no. Not always.

In today’s world, this would be similar to stating all books by Nicholas Spark which have dealt with the death until now has become a box office hit – so, his next book which talks about death will also be a box-office smasher! No.

We do not know that.

Technical Analysis states that it is possible to predict the price movements of stocks from the past data, if the movement is seen to have recurred over a span of time.

Most people miss out on the recurring part.

They often recur but not always – this is also a vital portion of the same rule.

Nonetheless, it would be unacceptable to state that studying only past price movements would help to determine the future prices – there is a lot of research and trend reading required to come to such a conclusion!

Overall, we see how trading is a rapidly growing field and it requires for the trader to be aware of the share prices before being completely indulgent in the stock market game.

When you are not certain of market position, always make small commitments.

There are exceptions to every rule prescribed by traders but it is important for us to remember to look beyond the emotions and invest in what we believe could work out well for us.

So, one must make trading an emotionally as well as financially rewarding experience where each day a new trick is learned!

If you think this article has helped you out with details regarding the Indian Share Market, wait till you see the growing e-Learning console on our website www.stockmarketsignals.com !