Profiting from financial assets becomes easier if the trader can forecast the future behavior of prices. One of the tools for making such a forecast is to perform technical analysis of charts. It is based on 3 basic postulates: prices are influenced by any political and economic factor, prices are subject to trends, and history repeats.
The moving average is an indicator. It shows the average price of the asset as a line next to the chart.
Moving averages belong to the category of trend indicators. These tools help to determine whether the price of an asset is rising or falling at the moment, and to predict where it will go in the future — will it continue to move in the same direction or turn around. There are several types of moving averages. They differ from each other in the way of calculation, but are used for the same purpose: determine the direction of the trend and find the entry points into the market. Moving averages are one of the most popular indicators. Many novice traders begin to study technical analysis with them. In addition, most of the oscillators of other groups of indicators are calculated on the basis of moving averages. Understanding how moving averages work helps you learn how to use oscillators.
An oscillator is an indicator that helps identify when a price reverses and for trades when a sideways trend occurs.
Oscillators are usually used for trading on trend reversals. At the same time, they can be used to trade in the direction of a price movement.
Traders use oscillators for the same purpose as other indicators: to more accurately forecast how an asset’s price will change and find the best moments to enter the market.
The ability to properly use indicators helps improve trading performance. Examples of oscillators are RSI, Stochastic, and MACD.
Moving average (MA for short) is an indicator: a tool that analyzes the market and helps predict whether the price of an asset will rise or fall. MA is calculated on the basis of past prices and displays the averaged, smoothed price of the asset without the noise from random fluctuations for a selected period.
Visually, the moving average is a line. This line follows the chart, so MA is a trend indicator. It helps to determine the direction of the price movement and find the moments when the price will turn around. Thus, the moving average is a tool for trend trading. There are 3 main types of moving averages: simple moving average (SMA for short), weighted moving average (WMA for short) and exponential moving average (EMA for short).
A simple moving average (SMA) is the simplest indicator in the moving average group. When calculating the SMA, all price information has the same weight, so the SMA is slightly less accurate than WMA or EMA.
The SMA has one configurable parameter: the period. The longer the period, the smoother the moving average (the SMA reacts to quote changes less often). The shorter the period, the faster the indicator (the SMA reacts to quote changes more often).
The number and accuracy of SMA signals depends on the period. The longer the period, the fewer signals the indicator gives, but they are more accurate. The shorter the period, the more the signals, but they are less accurate.
Traders use a simple moving average to identify a trend and see where it ends. If using the SMA, trading should occur in the direction of the price movement.
If the indicator line goes up, it means that the trend is upward, i.e., the asset price is increasing and you can open Up trades. If the SMA goes down, then the trend is downward i.e., the price is falling and you can open Down trades.
The intersection of the chart and the SMA line gives a signal to open trades. If the chart crosses the moving average going upward, this is a signal to open an Up trade. If the chart crosses the SMA going downward, this is a signal to open a Down trade.
Like all MA, weighted moving average (WMA) helps to determine the direction of the trend, finds its reversal points, has a customizable period and shows the average price of the asset.
WMA differs from SMA in the way it is calculated. If all details have equal weight with the SMA, the WMA ranks price values. It assigns a certain weight to each value. The newer a price is, the more important it is, the older it is, the less important it is. In this case, the weight varies from each price to the previous linearly by the same amount.
For example, the last price gets fivefold weight, the previous price — fourfold, the price going before — threefold and so on. Due to this, fact the WMA responds more quickly to fluctuations in the price of the asset.
Open trades using WMA should also be in the direction of price movement. If the chart crosses the indicator from top to bottom, the price of the asset is likely to continue to fall, and you can trade to descrease. If the chart crosses WMA from the bottom up, the price of the asset is likely to continue to grow, and you can trade to increase.
Exponential moving average (EMA) is similar to SMA and WMA. It also shows the average price of the asset, helps to determine the trend and find its reversal points, and has a customizable period.
The difference is in the method of calculation. EMA, like WMA, assigns its weight to each price value, and the most important are the latest changes in the price of the asset. But, unlike WMA, the weight changes from each price to the previous one not linearly with EMA but by different values.
For example, the last price gets weight 2.0, the previous price — 1.6, going before it — 1.0 and so on. As a consequence, the EMA is faster than SMA and WMA, regarding how it responds to price fluctuations.
The exponential moving average is suitable for intra-day trading and trading on volatile assets. This indicator is convenient to use on a candlestick chart.
It is recommended to open a trade on the asset price reversal. If the EMA line has changed in direction, it turned up after moving down and vice versa, and crossed the chart candle, then the trend has changed.
If EMA stopped moving down, turned up and crossed the chart candle, most the asset price will most likely continue to rise. You can trade to increase.
If the moving average stopped moving up, turned down and also crossed the candle chart, the price of the asset will most likely continue to fall. You can trade to discrease.
If you use 2 moving averages of the same type at the same time but with different periods, you can keep track of price reversals. A possible change in the trend is indicated by crossing lines.
The moving average crossover strategy is best used on a candlestick chart.
The patterns that form the lines of the 50 and 200-day average are called the “golden cross" and "death cross”.
The Golden Cross is a pattern that appears on the chart when the 50-day moving average crosses above the 200-day moving average and both lines are rising. A moving average with a shorter period is called "fast" and a moving average with a longer period is called "slow".
The Golden Cross indicates that an uptrend has formed on the chart.
Similar to moving averages with 50 and 200 days, you can use two moving averages of different periods. For example, a trader has added two SMAs to the chart: a "fast" one with a period of 5 and a "slow" one with a period of 15. If the “fast” SMA crosses the “slow” line going upwards and both moving averages rise, the asset price is likely to rise as well. You can then make an Up trade.
The Death Cross is a pattern that appears on the chart when the 50-day moving average crosses below the 200-day moving average and both lines are falling.
The Death Cross indicates that a downtrend has formed on the chart.
Similar to moving averages with 50 and 200 days, you can use two moving averages of different periods. We’ll use the same example with two SMA: “fast” with a period of 5 and “slow” with a period of 15. If the “fast” SMA crosses the slow one going downwards and both moving averages are pointed downwards, the asset price is likely to fall. You can then open a Down trade.
Momentum shows the speed at which an asset price has changed from one period to another.
In technical analysis, Momentum is an indicator. Momentum is calculated as the ratio between the current price of an asset and its price N periods ago.
There is a trading technique momentum - style trading, when traders focus on stocks, the price of which are dynamically moving in one direction.
The essence of the style is to assess the behavior of shares relative to the behavior of the market. To do this, traders evaluate whether the shares are moving with or against the market, whether they have enough volume, and how they behave in comparison with the initial forecast.
The strategy is based on short-term changes in share prices, not on their fundamental value. When choosing a moment to buy or sell, pay attention to the strength of trends that have formed on the asset.
If the value of the asset is actively growing, then an uptrend has formed and it is possible to place up trades.
On a downtrend, when the price is dynamically going down — place down trades.
Momentum is also an analytical tool. It’s an oscillator that helps identify market trends.
It’s worth noting that Momentum does not identify oversold and overbought conditions like other oscillators. The indicator’s movement is tied to its zero line.
Trading with the Momentum tool is also based on trend trading. Two conditions must be met at the same time to open trades: a trend has formed on the chart and the indicator line crosses 100; or the indicator line crosses its moving average.
Open Up trades on an uptrend when the indicator line crosses 100 going upward or when the indicator line crosses its moving average going upward.
Open Down trades on a downtrend when the indicator line crosses 100 going downward or when the indicator line crosses its moving average going downward.
Overbought and oversold markets are zones from which traders expect the price chart to reverse. It can be a small correction or a complete trend change.
Overbought and oversold are determined by certain oscillators, such as Stochastic, RSI, etc.
Overbought is when an asset’s price has risen considerably and may start to drop. An example of overbought conditions is if the RSI indicator is above 70.
After overbought conditions appear, the trend may reverse and the price starts to fall after the increase.
Oversold is the opposite situation, where an asset’s price has dropped sharply and may start to rise. An example of oversold conditions is if the RSI indicator is below 30.
After oversold conditions appear, the trend may reverse and the price starts to rise after the drop.
Divergence is a situation when the chart and the oscillator move in different directions: one goes up and the other goes down.
If there is a divergence between the chart and the oscillator, a trend reversal is possible, and the price will begin to fall after growth and vice versa.
There are 2 types of divergences: bearish and bullish.
Bearish divergence is a divergence where the chart moves up, showing an uptrend, but the oscillator moves down. The most powerful divergence is considered to be when the oscillator is in the overbought zone.
With a bearish divergence, the asset price may reverse and start to fall after the rise.
Bullish divergence is when the chart moves down showing a downtrend, but the oscillator moves up. The most powerful divergence is considered to be when the oscillator is in the oversold zone.
If a bullish divergence is formed on the chart, the asset price may reverse after the fall and go up.
Convergence, as well as divergence, is also a divergence between the chart and the oscillator, but in the opposite direction: the chart moves down and indicates that the price is falling, and the indicator is directed up and indicates the growth of the price.
In convergence, as in divergence, the trend may reverse and the price will start to rise after the decline.
The Relative Strength Index (RSI) is an oscillator. It helps to determine the price reversal points in the market’s flat (sideways) phase.
The indicator also allows you to identify overbought and oversold conditions. Like other oscillators, the RSI is best for trading on trend reversals, but it can also be used for trading in the direction of a price movement or on a sideways trend.
RSI is based on the ratio of the amount of the upward price changes to the amount of the downward changes over 14 days. This period was used by the oscillator’s creator, and we recommend using it.
If you increase the RSI period, the oscillator will give fewer signals, but they will be more accurate.
The RSI line can move between 0 and 100. In doing so, it crosses 30 and 70. The zone below 30 is the oversold zone and above 70 is the overbought zone.
The main principle of trading using RSI is that you need to trade when the indicator leaves the overbought and oversold zones.
If the indicator line leaves the oversold zone, then you can open Up trades.
This is a situation where the indicator is below 30 and starts to rise, crosses it going upwards, and continues to rise.
The entry point to the trade will be the moment it crosses 30.
If the line of the indicator leaves the overbought area, it can open the down trade.
This is the situation when the indicator begins to decline to the level of 70, crosses it from top to bottom and continues to fall.
The point of entry into the trade will be the moment of crossing the overbought level.
The second signal to buy an asset is the appearance of a bullish divergence between the chart and the indicator.
In case of bullish divergence, you need to look at the lows of the price chart and the RSI indicator.
If the chart continues to decline, and the indicator, on the contrary, grows, we should expect a trend reversal and the beginning of an uptrend.
The second signal to sell the asset is the appearance of a bearish divergence between the chart and the indicator.
When bearish divergence you need to look at the highs of the price chart and the RSI indicator.
If the chart continues to grow, and the indicator, on the contrary, decreases, we should expect a trend reversal and the beginning of a downtrend.
Stochastic is an oscillator. It helps identify overbought and oversold conditions.
The Stochastic oscillator can be used for trading in the direction of a price movement, but this oscillator is best suited for trading on a sideways trend and price reversals.
Overbought is when an asset’s price has risen considerably and may start to drop.
After overbought conditions appear, the trend may reverse and the price starts to fall after the increase.
Oversold is the opposite situation, when the price of an asset has fallen considerably and may start to rise.
After oversold conditions appear, the trend may reverse and the price starts to rise after the drop.
The indicator consists of two lines – %K and %D. %K is the fast primary line, usually with a period of 14. It is additionally smoothed out using the "slowdown" parameter with a period of 3. This smoothing improves the accuracy of the indicator’s signals.
%D is a slow line. It is calculated as the moving average from the %K line and has a period of 3.
These lines can move between 0 and 100. In doing so, they cross 20 and 80. The zone below 20 is the oversold zone and above 80 is the overbought zone.
You can trade on the increase when the %K line is out of the oversold zone, that is, crossed the level 20 from the bottom up. If the fast line %K crosses the slow %D from the bottom up, this additionally confirms the signal.
Please note: it is not recommended to enter the market only on the basis of %K and %D lines crossing. This is a weak signal, which is often false.
You can trade on the decline when the %K line is out of the overbought zone, that is, crossed the level of 80 from top to bottom. If the fast line %K crosses the slow %D also from top to bottom, this additionally confirms the signal.
As in the case of trading on the increase, it is not recommended to open a trade in the fall only on the basis of the intersection of the oscillator lines.
Divergence is a situation where the chart and the Stochastic oscillator move in different directions: one rises and the other falls. If a divergence appears between the chart and the oscillator, a trend reversal is possible, and the price will begin to fall after the rise and vice versa. There are 2 types of divergence: bearish and bullish.
Bearish divergence is a divergence where the chart moves up, showing an uptrend, but the oscillator moves down. The divergence is stronger if the indicator is in the overbought zone. With a bearish divergence, the asset price may reverse and start to fall after the rise.
Bullish divergence is when the chart moves down showing a downtrend, but the oscillator moves up. The divergence is stronger if the indicator is in the oversold zone. If a bullish divergence is formed on the chart, the asset price may reverse after the fall and go up.
Note: if a divergence appears on the chart and the oscillator is in the neutral zone between 20 and 80, it is not recommended to enter the market. This is a weak signal.
Parabolic SAR is a trend indicator: an analytical tool that helps determine the direction of price movement and perform trend trading. SAR is short for “stop and reverse”.
Parabolic SAR works best in a strong trend market. It is not recommended to use the indicator for trading high volatility assets and trading on a sideways trend. In this case, Parabolic SAR often gives false signals.
Visually, Parabolic SAR is a series of points that are located under or above the graph. The dots indicate whether the price of the asset is rising or falling.
This line of points has a period of 0.02. It was calculated and used by the creator of the indicator, so it is recommended to use this value.
If you increase the period, the Parabolic SAR will give more signals, but many of them will be false. If you reduce the period, the indicator signals will become more accurate, but their number will decrease.
– A Parabolic SAR always moves, regardless of whether the price of the asset changes. For example, if the trend was down and then became sideways, the indicator will still move down. In this situation, the market should refrain from transactions, because a Parabolic SAR gives a lot of false signals.
– The farther the indicator points are from the chart, the stronger the trend. The closer the points are to the chart, the more likely a price reversal is.
– The Parabolic SAR gives the most accurate signals when there is a clear up or down trend in the market.
You can make an Up trade if there is a clear uptrend on the chart. Stable growth of the asset price is confirmed by the following indicator signal: Parabolic SAR points are plotted below the chart, and the line of points moves upward.
Use additional analytical tools to confirm the Parabolic SAR signal. For example, MACD lines can be used.
If there is a strong downtrend on the chart, you can trade for a downtrend. A steady drop in the price confirms the following indicator signal: parabolic SAR points are plotted above the graph, and the line of points moves from top to bottom.
As in UP trades, in DOWN trades it is recommended to confirm the signals of Parabolic SAR with other tools as well for technical analysis.
The Parabolic SAR often unfolds, especially in a sideways trend and in a market with high volatility. So, if the points were above the chart, and then began to form under it, or Vice versa, the indicator changed direction.
The reversal of a Parabolic SAR does not always mean that the price has also changed direction. In most cases, it only indicates that the graph and Parabolic SAR intersected. For this reason, opening trades based on parabolic SAR reversals should be done with caution.
You can enter the market for an increase, if after a downtrend on the chart formed 2 green candles, and under them there were points.
You can trade on the downside, if after an uptrend on the chart there were formed 2 red candles, and above them there were points.
Use additional analysis tools to confirm true trend reversals and filter out false signals.
MACD is both a trend indicator and an oscillator: a type of indicator that helps determine the direction of a trend, find price reversal points, and trade on a sideways trend. MACD is short for “moving average convergence/divergence”.
The MACD indicator consists of two indicators – MACD lines and the MACD histogram. MACD lines are more related to trend indicators, while the histogram can be seen as an oscillator.
MACD oscillators consist of 2 lines: one directly to the MACD line (main line) and the signal line.
The main line, AKA MACD line, is calculated as follows: EMA with a period of 12 subtracted EMA with a period of 26.
The signal line is a moving average with a period of 9. An exponential or simple moving average is used as a signal line.
The intersection of the lines of the indicator is what gives signals to enter the market.
Trade to increase if the oscillator gives the following signals:
– The MACD line crosses the signal line from bottom to top.
– Both lines go up.
A clear uptrend should be formed on the chart.
Trade to discrease if the indicator gives the following signals:
– The MACD line crossed the signal line from top to bottom.
– Both lines went down.
At the same time, there should be a clear downtrend on the chart.
Divergence is a disparity between the direction of the chart and the MACD histogram, where the chart moves up and indicates a rise in an asset’s price, while the MACD histogram is pointed down and indicates a drop in price.
If a divergence has formed between the chart and the MACD histogram, a trend reversal is possible, and the asset price may start to fall after the rise.
It is important to remember that divergence is a weak signal that is often inaccurate. It is not recommended to enter the market using only this signal. If you combine MACD with another oscillator, you can use the divergence as an auxiliary signal to confirm the signal from the main indicator.
Convergence is also a disparity between the chart and the MACD histogram, but in the opposite direction: the chart moves down and indicates that the price is falling, and the indicator is pointed up and indicates an increase in price.
In convergence, as in divergence, the trend may reverse and the price may start to rise after a fall.
Convergence, like divergence, is an inaccurate and weak signal. Use it as a way to help confirm other, stronger signals.
Like all MA, weighted moving average (WMA) helps to determine the direction of the trend, finds its reversal points, has a customizable period and shows the average price of the asset.
WMA differs from SMA in the way it is calculated. If all details have equal weight with the SMA, the WMA ranks price values. It assigns a certain weight to each value. The newer a price is, the more important it is, the older it is, the less important it is. In this case, the weight varies from each price to the previous linearly by the same amount.
For example, the last price gets fivefold weight, the previous price — fourfold, the price going before — threefold and so on. Due to this, fact the WMA responds more quickly to fluctuations in the price of the asset.
Open trades using WMA should also be in the direction of price movement. If the chart crosses the indicator from top to bottom, the price of the asset is likely to continue to fall, and you can trade to descrease. If the chart crosses WMA from the bottom up, the price of the asset is likely to continue to grow, and you can trade to increase.