Technical indicators use mathematics and statistics to establish patterns, by using pricing and volumes over time, in order to filter and balance price floats and finding trends and their intensity. There are many technical indicators, but the investor needs to be thorough while choosing between them, not trying to analyzing all at the same time. There are three main categories of indicators: moment, volume and trending. Remind that, while analyzing graphsm you must follow indicators in a same category, as information from different categories may diverge. However, that’s not an universal rule.
Moment indicators, also known as up-and-down indicators, are used to find signs of buying and selling at certain moments and situations. Volume indicators, on the other hand, look at trading volumes to validate pricing moves.
Moving averages
Moving averages are graphical demonstrations which atenuate pricing moves and provide a better view on trends that appear. Besides, it increases the “memory” effect, so if prices drift away from averages, that shows to investors that prices can be cheap or expensive, acting as a kind of “magnet” of prices. There are three types of moving averages: simple, weighted and exponential.
Simple moving average
A simple moving average takes closing prices and is calculated with a certain number of days for a specific period of time. The average is always found for a period, moving as time goes by. For instance, if the average is calculated over 21 days, the comparison will be always made over the last 21 days, and that moves on time, always looking at closing prices to avoid a anticipate market moves.
A longer average is less sensitive to pricing changes than a shorter one, being less exposed to wrong conclusions and volatile. This is because the weight of the new price becomes smaller as the number of days increases. However, long moving averages might be giving investors a delayed information on moves and trends. A tip for investors is to keep the averages in consonance with the periods of their investments. If they a dealing with long term assets, the average needs to be long, if not, they can work with a shorter version.
A problem with simple moving averages is that all prices have a same weight. When the last price is cut and a new price is considered, the average is clearly affected. Below you can find an example of simple moving average for FIBR3 with a 21 days period:
Weighted moving average
The weighted moving average is more often used than the simple one, in which latest quotations are more relevant than the first ones. For the simple moving average, all quotations have the same weight. For the weighted moving average, the more recent quotations have a higher weight. The weight is reached by using the latest quotations twice or more or even charging them with an extra weight, multiplying. Below you can see an example of a 21 days weighted moving average for FIBR3 shares.
Exponential moving average
The exponential moving average doesn’t consider any data out of the choosen period, and gives all prices the same weight. However, it gives more importance to the latest prices, with a characteristic of weighted averages, but the weight progressively decreasing applies to all past prices and not only to those which form the average. Below you can find an example of a 21 day exponential moving average for FIBR3 shares:
Moving averages are trend trackers. If averages are increasing, shows that buyers are stronger than sellers. If descendant, who is winning are sellers. Also, moving averages give investors a support for finding the natural level of prices. This way, the investor should only use moving averages in defined trends. If he uses the moving averages in the average lateral trends, he may be confuse, beyond the average itself generate false signals.
Examples of moving averages use:
Choose an asset with a visible upward or downward trend. In this case, we used FIBR3. Trace two exponential moving averages, the first for 11 weeks (blue) and the second for 22 weeks (yellow), as follows:
When the shorter average (11 weeks) cuts the longer (22 weeks) from the bottom to the top, that implies in a buying signal, and while the shorter average line stays above, so assets should be put on hold. When the opposite happens, when the shorter average (11 weeks) across from top to bottom the longest average (22 weeks) will be a sell signal, and while it remains below the longest moving average, the short position will be maintained. One of the problems of using this strategy is the signal delay, which may inform the investor the beginning of the trend a little late, causing him to miss the start of this trend.
Moving Average Convergence/Divergence – MACD
The MACD – Moving Average Convergence/Divergence – is a technical indicator that provides signs of buying or selling trends from intersections between the indicator’s line and its moving average. The MACD moves around a center line of zero, with no upper or lower limit, where this line is an area where there is a balance between supply and demand. Therefore, the more the MACD moving away from this balance area, the greater the pressure for her to eventually return to equilibrium.
The construction of MACD is done as follows: First, there is a line MACD being the difference between exponential moving averages taken over distinctive periods. Then there is the signal line which corresponds to the exponential moving average MACD itself. Finally, there is the histogram, which represents the difference between the MACD and the signal line, which serve as an indicator for the purchase or sale of the paper.
When the MACD (blue line) crosses the “signal” (green dotted line) from bottom to the top, an opportunity of buying emerges, and while the line stays above, the investor should hold any purchased shares. Otherwise, if MACD line crosses the “signal” from top to the bottom, the investor should sell his positions and wait the line to cross the signal once more before making any new move. MACD may provide delayed signs, because it is also an indicator that follows a trend, so it has to be used on very clear trends only.
Relative Strength Index – RSI
The RSI measures the interaction between the supply and demand forces within a market. It can be expressed as a percentage, where their bands moves between 0% and 100% and finds a neutral position at 50%. When prices exceed the neutral zone towards 100%, the buying pressure is high and the market is overbought, which may lead to price hikes. When it is very close to 100%, can be a sale sign of the asset. On the other hand, if the RSI falls below 50%, approaching 0%, the selling force is bigger, and the market is oversold, so prices tend to drop. When this happens, you may be given a buy signal. That happens because whatever the trend is, prices and market conditions tend to move back to the neutral zone, or 50%.
One doesn’t need to wait the RSI to reach 0% or 100% to get a good indication for buyig or selling moves. In fact, this is one of the RSI’s major problems: to establish ground levels for triggering buying and selling moves. For such, simply draw a line in the index, linking major points in the period analyzed. In the graph above of PETR4, the dots below are reaching something like 17% in the RSI scale, while the dots above are reaching 70%. So, when the RSI hits 17%, that’s a buying sign, and if that reaches 70%, a selling sign.
Bollinger Bands
The Bollinger Bands consist of a combination of three bands. The one in the middle is a moving average for 20-period variations of the closing price. The upper band is plotted by adding twice the standard deviation of the central band of the central band and the lower band, drawn by subtracting twice the standard deviation of the central band of the central band itself.
The probability of the candles (prices) to stand inside the bands equals to 95%, which makes them very effective in analyzing prices and estimate future levels. For shorter periods of time, one can use moving averages for 11 positions and a 1.5 standard deviation. For long term trends, the best is to use a 50 positions moving average and a 2.5 standard deviation. Also, the exponential moving average can replace the simple moving average for that.
Reading from Bollinger bands is quite simple. When the prices are above the average and close to the superior band, that implies the shares are overbought or overpriced, a sign that it’s the time for selling them. On the other hand, if prices are below the average and are closer to the lower band, they should be oversold, and that’s the best time for buying them. If a candle stand outside the upper or lower band, most likely there will be a correction because prices are only 5% of the bands out. When the bands narrow, indicating a period of low volatility, prices can produce powerful movements when the lull is over.
Stochastic
The indicator has been developed to find overbought or oversold regions on graphs. It moves in a 0-100 scale, and whenever it reaches 20 or 80, a signal for buying or selling is given. It was created on the observation that when prices fall, closing near the minimum, and when it goes up, closes near maximum.
This indicator has two lines. The first is the %K (green) and the second is the %D (blue dotted). Any time that %K cuts from bottom to the top the %D, we have a buying signal, however, the cut must happen inside the oversold region, between 0 and 20. If %K cuts %D from top to the bottom, we have a selling signal, where should occur in the overbought region, between 80 and 100. This indicator is highly sensitive and needs to be adjusted according to the period.
On Balance Volume
The trading volume is a strong indicator on technical analysis. The On Balance Volume is an indicator that anticipates a change on pricing directions. When prices hike and the trading volume increases, there is a trend that prices keep rising. If prices soar but the volume does not follow the trend, then the hikes are losing their strength. If prices drop and the volume of trading increases, they should keep decreasing, but if the volume is not increasing together, the drops should stop at certain time. The table below summarizes that:
Price |
Volume |
Trend |
If prices increase |
And the volume is high |
Trend is upward |
If prices increase |
And the volume is low |
Trend is downward |
If prices drop |
And the volume is high |
Trend is downward |
If prices drop |
And the volume is low |
Trend is neutral |
The OBV indicates the divergence or convergence between peaks and troughs. For instance, when two peaks on a pricing graph are in line with two peaks on the OBV, we have an indication of steadiness and a continuing trend. If the OBV does not follow those two peaks, though, a price change may occur.
The OBV is built by using the closing prices and the amount of shares traded. It is intended observing the change rates and the formation of the line of OBV. If any divergence happens between both, the trend may change. If increasing prices are not being followed by the trading volume, that is a sign that buying activity is weakening, so a change is likely to happen in the trend. However, the indicator is not 100% reliable, so the investor should be looking at more fundamentals to base his decisions.
Fibonacci
The Fibonacci sequence was developed by the Italian mathematician Leonardo Fibonacci in the XIII century, and through these numbers one can find the golden proportion, a relation found in the human body (finger bones), proportions on dimensions in seashells and hives, and other applications. If those proportions were transformed into percentage, give us the values of 38.2%, 50% and 61.8%. The golden proportion is widely used for financial purposes as well.
Through the Fibonacci sequence, it is possible to know in advance the target price that a particular asset will reach after breaking a support or resistance, as well as showing the probable points of support and resistance prices will want to achieve, make a correction or continue following its trend.
To use Fibonacci, one just needs to open a graph and analyze a particular period (short term or long term). After that, it is a matter of tracing the Fibonacci lines, reaching the tops and bottoms, just like the following illustration:
As we can see in the graph above on the stock CSNA3, it sustained a long downward trend. Prices peaked at R$ 12.41 on 100% of Fibonacci line. After that, they dropped to the second line (61.8%). This second line was a support, and a breakout didn’t happen at once, and prices recovered for a while before breaking down the line. After breaking the 61.8% line, the prices kept dripping and testing all the bottom lines and supports (38,2%, 14,6%, 9%), breaking one after another, until getting to the 0% level.
Prices couldn’t break this line, and started rising back, breaking all resistances while soaring gradually, until they got to reach the 61.8% line again, where prices experienced a long steady moment, until reaching again the 100% line, at maximum prices. Notice that prices could not break the last resistance, which indicates that they should be dipping back to 61.8%, eventually having strength enough to break the 100% barrier.
TRIX
The TRIX indicator – a triple exponential moving average – is a powerful tool for technical analysis. It works as an oscillator, showing oversold and overbought areas, and as momentum indicator, determing the strength of a trend. The TRIX, when used as oscillator, moves around the zero, and the higher it is, the stronger is the indication of overbuying, and the lower it is, the more oversold the scenario shall be. As momentum indicator, the line indicates whether a trend is gaining strength or not.
The advantage of using the TRIX is that it removes much of the movements that cause distortions in time to indicate a change of trend, in addition to signals before other indicators of changing trends. Like other indicators, their use is more reliable when used with other indicators in order to have a better basis on signs of price changes and trends.
“Needle Prick” oscillator
The “Needle Prick” indicator was created by a Brazilian – Odir Aguiar, or Didi by his nickname. He noticed a particular behavior for the moving averages on the 3rd, the 8th and the 20th periods. These moving averages should be analyzed together, where the average of 8 periods is always constant horizontal. The other two moving averages of 3 and 20 periods, form an indicator to buy or sell, when there is a junction where the averages 3 and 20 periods is above the 8 line periods, have a “needle prick”. In the oscillator, all moving averages are divided by 8, so the moving average of eight days is a straight line, since its value is equal to one. Note the chart below:
The blue horizontal line is the 8-day moving average. It doesn’t oscillate, and keeps flat. The red line is the 20-day moving average and the green line the 3-day average. Any time the green line cuts the red line from bottom to the top, and exceed the blue line levels, we have a “buying prick”. Opposingly, if the green cuts the red towards the area below the blue line, then we have a “selling prick”. The 3-day and the 20-day moving averages follow the pricing developing in the graph.
The needles of Didi mark only the beginning of the trade and never the end, and other indicators should be used to exit the trade. It is always important to wait for the following to confirm the buy signal or sell candle.