An indicator may flash a buy signal, but if the chart pattern shows a descending triangle with a series of declining peaks, it may be a false signal. What is the indicator saying about the price action of a security? Is the price action getting stronger? Weaker?Įven though it may be obvious when indicators generate buy and sell signals, the signals should be taken in context with other technical analysis tools. Any analysis of an indicator should be taken with the price action in mind. This should be taken into consideration when applying analysis. As such, they are derivatives and not direct reflections of the price action.
Indicators filter price action with formulas. This may sound straightforward, but sometimes traders ignore the price action of a security and focus solely on an indicator. By applying a 10-day simple moving average to the price action, random fluctuations are smoothed to make it easier to identify a trend. Veritas (VRTSE) displays a lot of volatility and an analyst may have difficulty discerning a trend.
A moving average filters out random noise and offers a smoother perspective of the price action. If a security is exceptionally volatile, then a moving average will help to smooth the data. Regardless of the complexity of the formula, technical indicators can provide a unique perspective on the strength and direction of the underlying price action.Ī simple moving average is an indicator that calculates the average price of a security over a specified number of periods. Others, such as Stochastics, have complex formulas and require more study to fully understand and appreciate. Some, such as moving averages, are derived from simple formulas and the mechanics are relatively easy to understand. Sometimes indicators are plotted on top of the price plot for a more direct comparison.Ī technical indicator offers a different perspective from which to analyze the price action. Once shown in graphical form, an indicator can then be compared with the corresponding price chart of the security. For analysis purposes, technical indicators are usually shown in a graphical form above or below a security's price chart. By creating a time series of data points, a comparison can be made between present and past levels. A series of data points over a period of time is required to create valid reference points to enable analysis. However, one data point does not offer much information and does not make for a useful indicator. For example, the average of 3 closing prices is one data point. The price data is entered into the formula and a data point is produced. Some indicators may use only the closing prices, while others incorporate volume and open interest into their formulas. Price data includes any combination of the open, high, low or close over a period of time. A technical indicator is a series of data points that are derived by applying a formula to the price data of a security.
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