Technical Indicators

Technical Indicators

Relative Strength Index (RSI):

This index is a popular indicator for the Forex (FX) market. The RSI measures the ratio of up-moves to down-moves and normalizes the calculation so that the index is expressed in a range of 0-100. If the RSI is 70 or greater then the instrument is considered overbought (a situation whereby prices have risen more than market expectations). An RSI of 30 or less is taken as a signal that the instrument may be oversold. (“Oversold” referrer to a situation whereby prices have fallen more than market expectations).

Stochastic Oscillator:

This is used to indicate overbought/oversold conditions on a scale 0-100%. The indicator is based on the observation that in a strong upside trend, closing prices for periods tend to be concentrated in the higher part of the period’s range. Conversely, as prices fall in a strong downside trend, closing prices tend to be near to the extreme low of the period range

Stochastic calculations produce two lines, %K and %D which are used to indicate overbought/oversold areas of a chart. Divergence between the stochastic lines and the price action of the underlying instrument gives a powerful trading signal.

Moving Average Convergence Divergence (MACD):

This indicator involves plotting two momentum lines. The MACD line is the difference between two exponential moving averages and the signal or trigger line which is an exponential moving average of the difference. If the MACD and trigger lines cross, then this is taken as a signal that a change in trend is likely.

Number Theory

Fibonacci numbers:

The Fibonacci number sequence (1, 1, 2, 3, 5, 8, 13, 21, 34…..) is constructed by adding the first two numbers to determine the third n umber that follows. The ratio of any number to the next larger number is 62%, which is a popular Fibonacci retracement level. The inverse of 62%, which is 38%, is also used as a Fibonacci retracement level. (Combined with the Elliott wave theory, see hereunder)

Gann numbers:

W.D. Gann was a stock and commodities trader working in the 50’s who reputedly made over $50 million in the markets. He made his fortune using methods which he developed for trading instruments based on relationships between price movement and time, known as time/price equivalents. There is no easy explanation for Gann’s methods, but in essence he used angles in charts to determine support and resistance areas and predict the times of future trend changes. He also used lines in charts to predict support and resistance areas.

Waves

Elliott wave theory:

The Elliott wave theory is an approach to market analysis that is based on repetitive wave patterns and the Fibonacci sequence. An ideal Elliott wave patterns shows five advancing waves followed by three waves of decline, referred to by A, B, and C.

Gaps:

Gaps are spaces left on the bar chart where no trading took place.

An ascending gap is formed when the lowest price on a trading day is higher than the highest price of the previous day. A descending gap is formed when the highest price of the day is lower than the lowest price of the prior day. An ascending gap is usually a sign of market's strength, while a descending gap is a sign of market's weakness.

A breakaway gap is a price gap that forms on the completion of an important price pattern. It usually signals the beginning of an important price move.

A runaway gap is a price gap that usually occurs around the mid-point of an important market trend. For this reason, it is referred to as a measuring gap.

An exhaustion gap is a price gap that occurs at the end of an important trend, and signals that the trend is ending.

Trends:

A trend refers to the direction of prices. Rising peaks and troughs constitute an upside trend while falling peaks and troughs constitute a downside trend. Peaks and troughs determine the steepness of a current trend. The breaking of a trend line usually signals a trend reversal. A trading range is characterized by horizontal peaks and troughs.

Moving averages are used to simplify and smooth price information in order to confirm trends, support levels, and resistance levels. Moving averages are also useful when choosing a trading strategy, particularly in futures trading or a market with a strong upside or downside trend.

For simple moving averages, the price is averaged over a number of days. On each successive day, the oldest price drops out of the average and is replaced by the current price. Hence, it calculates the average for the daily moves. Exponential and weighted moving averages use the same technique but weigh the figures-least weight to the oldest price, most to the current.