Indicator Overview
Most indicators represent the momentum of the price trend. In technical analysis, momentum is another word for Rate-of-Change. Most indicators represent the ROC or the speed of the price trend.
Price and indicator values usually trend in the same direction but not always.
The indicator may trend in the opposite direction of price which represents a slow down in the ROC or momentum of the price trend.
New Terms
Overbought (OB): A relatively high indicator value. When the indicator is in a position for price to make a momentum high but not necessarily a price high.
Oversold (OS): A relatively low indicator value. When the indicator is in a position for price to make a momentum low but not necessarily a price low.
Indicator Differences
While almost all indicators are similar in that they represent the momentum of the price trend, they do display this information differently. Some of the differences between the indicators are -
The sensitivity they have to the momentum or ROC of the price trend.
Whether they have a value limited to 100 or have unlimited values If they have a maximum values of 100, they will have overbought and oversold zones. Whether they reach an OB or OS zone at most momentum reversals
Indicators with no maximum reading such as the MACD do not have OB and OS zones.
An OB indicator signals the upside should be limited before a momentum or price reversal is made.
An OS indicator signals the downside in price should be relatively limited before a momentum or price reversal is made.
An OB indicator signals the upside in price should be relatively limited before a momentum or price reversal is made.
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A momentum reversal may not coincide with a price reversal but the rate of price advance or decline should decrease following a momentum reversal.
Once we understand what an indicator and its position represents, we will be able to use that indicator for practical and objective trade strategies. We will also be able to identify which indicators will be the most useful for Dynamic Trading trade strategies.
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Chapter Four – Practical Indicator Strategies Module 3 – Indicator Settings
Indicator Settings Overview
Most indicators represent the same thing – The momentum or ROC trend. The terms momentum and Rate-of-Change (ROC) are used interchangeably for trading purposes.
The best indicator to use that will provide the clearest reversal signals is an indicator with two lines that cross on a momentum reversal. It could be an indicator with a fast and slow line or one with histogram bars and a signal line.
The crossover of the two lines is the signal of the change of price momentum.
The most useful indicators will oscillate from at or near the OB to OS zones with the momentum cycles.
Which Indicator To Use
There is not one best indicator to use. What is important is the trader
understands what the indicator represents. Study the indicator you use to learn how it reacts to price trends. The Stoc, RSI, MACD and DTosc are all good indicators to use.
Indicator Settings
Indicator settings reflect the “lookback” period of the indicator. The lookback period is the number of bars counting back from the most recent bar that are used to calculate the indicator.
The shorter the lookback period, the more sensitive to momentum changes.
With a too short setting, the indicator will reverse every time the ROC slows down.
The longer the lookback period, the more lag in the indicator reversal
compared to the price reversal. With too long a lookback period, the indicator will usually make a reversal too many bars after price has made a reversal.
The best settings are when price makes a reversal within 2-3 bars of the indicator reversal at a counter trend high or low.
Choose different settings and note which setting most consistently makes reversals that coincide with price reversals at counter trend highs and lows.
Settings are not the same for all markets or all time periods all of the time.
Indicators and Trend
Price does not necessarily reverse trend with momentum reversals. A
momentum reversal always represents a slowing down in the momentum of price but price may not actually reverse the direction of the trend is the momentum only slows down a modest amount.
Indicators are most useful to help identify if price is in a position to complete a correction.
Indicators are not as useful to help identify potential price extremes in the trend direction.
Indicators often stay in the OB zone for a bull trend or OS zone for a bear trend for some time before an indicator or price reversal is made.
The best indicator settings to identify the end of a counter trend are not necessarily the best to identify the end of the trend.
Since we want to trade in the direction of the trend, we choose the best setting to help identify the end of the counter trend in order to enter the trade in the direction of the trend.
Indicators and Practical Trade Strategies
Trades should be made in the direction of the price momentum.
The trend of the indicator will help identify which side of the market to trade.
The indicator will help to identify if a market is in a position to make a price high or low.
A useful indicator is one that oscillates closely with price oscillations with few
“false” signals.
What ever indicator is used, it must have an objective reversal signal. You will learn more about indicator reversal signals later in this chapter.
Most any indicator will be useful, as long as we are aware of how it acts and reacts to price trends, momentum and reversals. The proper indicator settings are important to accurately identify momentum and price reversals.
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