There are two types of indicators: Leading indicators help you profit by attempting to forecast what prices will do next. Leading indicators provide greater rewards at the expense of increased risk. They perform best in sideways or trading markets. They work by measuring how overbought or oversold a stock is. Lagging or trend-following indicators are best suited to price movements in relatively long trends. Lagging indicators have you buy and sell in a mature trend, when the risk is reduced.
The technical conditions of overbought and oversold are important to be aware of. Generally, the RSI quantifies the condition and gives you a number that acts like a barometer. On a reading of 0 to , the RSI becomes oversold at about the 30 level and overbought at about the 70 level. The RSI is a metric usually calculated and quoted by most charting sources and technical analysis websites.
For stock investors, the RSI is particularly useful for timing the purchase or sale of a particular stock. When you are looking at a favorite stock that you like and notice that its RSI is below 30, check to see whether anything is wrong with the stock did the fundamentals change?
That would be a bearish crossover, and it would indicate a good time to sell or risk further downward movement. Divergence occurs when the price of a stock and an indicator or index or other related security part company and head off in opposite directions.
Divergence is considered either positive or negative, both of which are signals of changes in the price trend. Positive divergence occurs when the price of a stock makes a new low while a bullish indicator starts to climb upward.
Negative divergence happens when the price of a stock makes a new high, but bearish indicators signal the opposite, and instead the closing price at the end of the trading day is lower than the previous high. Moving averages and other indicators are certainly important when the trend is clear, but oscillators are more beneficial under either of the following circumstances:.
Oscillators may be either leading or lagging indicators, depending on what type they are. Bollinger bands have nothing to do with musical groups. A band is plotted two standard deviations away from a simple moving average. The bollinger band a lagging indicator works like a channel and moves along with the simple moving average.
Bollinger bands help the technical analyst watch out for overbought and oversold conditions. Basically, if the price moves closer to the upper band, it indicates an overbought condition. If the price moves closer to the lower band, it indicates an oversold condition.
Top Technical Indicators for Stock Investors.More...