Technical Indicators: What are they and How to choose the Right Combination

Technical indicators and oscillators are a useful tool for traders analyzing the financial markets. There are several algorithms that can help in developing analyzes that are able to provide a complete picture of the market under examination.

Traditionally, there are trend, momentum and volatility indicators and oscillators. These three categories provide different information to the trader. Let’s see how we can best adapt them to our needs.

Another distinction that can be made in relation to algorithmic analysis tools is that of price, volume, breadth and hybrid indicators/oscillators.

Price, volume and breadth algorithms: what do they mean?

• The price algorithms are those that combine the information deriving from the basic concepts of the various candlesticks, i.e. maximum, minimum, opening and closing. This category includes the RSI, the CCI, the MACD and the ROC.

• The indicators/volume oscillators process the information deriving from the number of contracts traded for a certain asset in a different way. The On Balance Volume is one of these tools.

• The third category is that of width algorithms, which take into account another variable in addition to price and volume, i.e. the breadth of the market. By this term is understood the degree and quality of participation of shares in market movements. The famous A/D Line belongs to this category.

• The last classification, that of hybrid, includes the rest of the algorithms that consider other elements that do not fall within the three divisions described above, such as for example the Bollinger Bands and volatility.

Combining different indicators/oscillators: some tips

If the aim is to choose the right combination of indicators/oscillators, the main difficulty is to put together different types of information that confirm each other.

A very common mistake among novice traders is precisely that of seeing a "signal confirmation" from two or more algorithms which, in reality, provide the same indication and therefore rather than confirming, they duplicate the signal.

The advice in these cases is to experiment with each of these algorithms and to interpret what is reported based on the type of market.

How many indicators to use falls within the personal choices of a trader, but the important thing is to be aware of the tools being used thus avoiding duplication of information and get the greatest possible benefit from them.

For example: by putting together the RSI (momentum) oscillator, the MACD (trend) and a volume indicator we obtain three different perspectives which will allow us to frame the market conditions in an overall way.

Moving Average

One of the most common technical indicators to identify the overall market trend is the moving average. A moving average is a line drawn on a graph that shows the average price over a certain period of time. There are several types of moving averages, including the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). The SMA is calculated as the arithmetic mean of prices over a given period of time, while the EMA is a weighted average that gives more weight to the most recent prices. There are also moving averages of different lengths: the long moving average is less sensitive to price changes, but can provide more reliable and less false trading signals.

RSI Oscillator

Another common technical indicator is the Relative Strength Index (RSI). The RSI measures the relative strength of a financial instrument relative to its average price over a given period of time. The RSI can be used to identify overbought and oversold levels and to predict market turning points.

Momentum

The momentum measures how fast prices are changing. If the momentum is positive, it means that prices are rising at a faster rate than in the previous time frame, while if the momentum is negative, it means that prices are falling at a faster rate.

MACD

MACD is a technical indicator that combines moving average and momentum. The MACD line is calculated as the difference between the short moving average and the long moving average. The signal line is a moving average of the MACD line.

Bollinger Bands

Finally, one last important technical indicator is the Bollinger Bands analysis. Bollinger Bands are lines drawn on a graph that represent volatility levels. The upper band represents the higher level of volatility, while the lower band represents the lower level of volatility. When prices approach the upper band, it means that the market is overbought, while when prices approach the lower band, it means that the market is oversold.

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It is important to keep in mind that no technical indicator is foolproof and that it is always necessary to use more than one indicator to get a more complete view of the market. Furthermore, technical indicators should be used in conjunction with fundamental analysis, which focuses on the economic and business fundamentals of financial instruments, to gain a broader understanding of the financial markets and make informed decisions about investments.
In any case, it is important to do your research and choose a reputable financial intermediary before making any investment decisions.

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Please also note that information or research based on historical data does not guarantee future performance or results. Any opinions, research, analyses, prices or other information provided under the heading of general market commentary do not constitute investment advice.

Original article published on Money.it Italy 2023-02-03 12:29:00. Original title: Indicatori tecnici: quali sono e come scegliere la giusta combinazione