INDICATORS

Technical indicators compose a separate class of mathematical transformations, that allow to show those or these results. As a rule such primary indicators (from the point of view of technical analysis) is the price and the volume. However they are not the only "original sources". It also should be listed volatility, for example, or correlation with other financial instruments. We will talk about the price firstly to make the description more clear for the beginning traders.

There are some hundreds of more or less well-known indicators and thousands of different variations and authors' developments of different traders, that are less wide-spread, but are used in trading in some cases. We have no such a possibility to list all of them, that is why we will note two major classes of indicators: trend indicators (or trend-followers) and advanced (oscillators). Now we will review two examples for each indicator class.

TREND CLASS (TRENDS-FOLLOWERS) INDICATORS

In general it must be noted that these indicators show very clearly the prevailing trend. The weak side of these indicators is the fact that they delay a little, and work bad during flats. In the framework of this class we will review "Moving average" (MA) indicator and "Moving average convergence/divergence (MACD).

"Moving average" - is one of the simplest indicators. From the mathematic point of view it is average price of analyzed financial instrument for the last n-time intervals. The difference of "Moving average" from the simple average resides in the fact that while forming a new price bar, the first bar is taken into account unlike the last one. Thus the average "moves" to the right with the formation of new prices. Let us see the illustration. 

Picture 13. MA construction

The last (current) MA value in x-point, denoted by red sphere is a simple arithmetical average (sum of the value divided into its quantity) of n of last prices of the given financial instrument. B-area, noted by yellow colour - is a period of averaging, i.e. that bars quantity that takes for the MA value calculation. The larger averaging period the less "flexible" will MA be, and later it will react on the new trend. However it will filter better small and insignificant changes in price. The smaller MA period, the more sensible it will be, but it will lead to the situation when it will react on the price changes that do not compose a trend.

The arrow on the illustration shows the direction of the movement of this period (i.e. with the appearance of a new price the interval will move one bar right). On the illustration we can see, that in the beginning of the given period there is area that is equal to n (denoted as A), for which the value of moving average with n averaging period is impossible to define, because of lack of information.

As we can see on the illustration MA shows very good the general direction of the development of the trend, well smoothing small price fluctuations, which are not significant for the trading. We must note that MA indicator itself might be considered as the simplest numerical filter (NF). The delay is connected with the nature of MA. The size of delay is the half of averaging period.

In the conclusion of description of this indicator, it is noted, that there are lots of variants of calculation of moving averages. Firstly, not only n closing prices (close) may be the original source of data for MA calculation. Instead of it "Typical price" (Typical price = (High + Low + Close) or " Median price" (Median price = (High + Low) or other price features might be used. Also in the role of enter (enter features) another MA indicator may be used (in general, it may be any other indicator). In this case the phrase "double price smoothing" is used. On the analogy the price might be smoothen three, four and etc times, it has to be remembered that the smoothing like this increases the delay.

Secondly, there are different types of MA (simple, exponential, measured, smoothen etc). Apart from this there is the whole underclass of dynamic moving averaging that aims to adjust to the market. If the flat formation happens (where classic MA works badly), the averaging period of dynamic MA increases to decrease the quantity of false signals. As soon as the indicator fixes the beginning of the movement, MA period decreases sharply to reflect more flexibly a new trend.

Moving average convergence/divergence. This indicator is based on two exponential moving average convergence and is calculated as the difference between them. One of them is called "fast" and the other - "slow" (respectively to their periods). It is clear, that "fast" moving average convergence may be both higher and lower than "slow" one. And this leads to the situation when the size of difference between them can appear both in the area of positive numbers and negative ones. In the chart this data is denoted (as a rule) in the form of histogram, but they also may be depicted with a simple curve. Also the indicator has "signal" line that looks like simple Moving average convergence of histogram value.

Picture 14. MACD construction

MACD has a number of features.

Firstly, crossing:

• to buy in time of crossing of histogram signal line bottom-up;
• to sell in time of crossing of histogram signal line top-down.

Secondly, it is overbought/oversold, that may be judged by the analytics depending on the distance of histogram from zero value.

Thirdly, it is divergence. Bullish divergence appears when histogram MACD forms new maximums and the price cannot form them. Bearish divergence is the situation when histogram form new minimums, and the price cannot do the same. Divergences overbought and oversold areas are considered to be the strongest and the most significant signals.

Picture 15. MACD bullish divergence

As we can see on the illustration, at a-point the price has formed a local maximum that is correspond to MACD maximum at a-point. MACD indicator at b-point has formed a new maximum, that is larger than previous one. At the same time, at b-point the price cannot reach a-level.

It has to be noted that MACD is plotted in separate area of a chart (in contrast to MA that is depicted directly at the price chart).

OSCILLATOR CLASS

In this class we will review such indicators as StochasticOscillator and DeMarker.

StochasticOscillator is regarded to be one of the most wide-spread indicators and gives way only to MA. This indicator takes into consideration (when calculating) not only closing prices in that or this time interval, but also both maximums and minimums of the prices, that were reached during the same interval. It reflects closing price of the last time interval in relationship to price interval (from maximum to minimum) for n-intervals in the past. StochasticOscillator values are calculated in percents that is why it, as a rule, is built in separate frame with 0 to 100 interval, however, some variations of this indicator permit to build StochasticOscillator directly on the price chart.

According to the idea of creator of this indicator, J. Lane (the president of InvestmentEducatorsInc. corp.) in process of descendant trend formation the closing prices of bars are situated near the lower ground of the diapason (channel). In the contrary, during ascendant trend formation the closing prices stand near the maximum of the diapason (channel). These claims are quiet logical, because in case of descendant tendency the price constantly forms new minimum, and thus the last prices are situated near this minimum. In case of ascendant trend new maximums are formed constantly, and the closing prices respectively are situated near those maximums.

In the illustration you can see that while forming ascendant trend, the last closing prices "crowd" new upper ground of price diapason (channel).

Let us see the formula of formation of this indicator in details. It consists of two lines %K and %D. These names are the result of long research work, when a group of traders tried to find more convenient variant, giving names to new indicators like %A, %B, %c etc. %D (slow stochastics ) and %K (fast stochastics ) came out to be functional. Let us take into consideration n-periods. At this time interval we have a local maximum (it will be denoted as Maxn) and minimum (Minn )  Closing price will be C. 

Then 

%D - it is MA of %K for which, as a rule, very small averaging period is chosen. Moreover method of calculation of this moving average may be different (depending on trader), for example, simple MA, exponential MA etc.

There are following trading signals of this indicator:

• To buy subject to the line of indicator (%K and %D) will first lower in the oversold area (on default, it is 20%) and then leave it, starting to lift. To sell when the line of indicator (%K and %D) will first lift from the overbought area (on default it is 80%) and then leave it, going down.
• To buy when crossing %D line with %K bottom-up. To sell crossing %K line with %D line top-down.

Besides, the fact of reaching by the indicator (%K and %D) the overbought area itself can be regarded as a prove of the delaying of price rising tendency in near future, and the reaching the oversold area can be regarded as a signal of delay of price decrease. 

Analytics also track the divergences between maximum and minimum of the price, and corresponding extremums of the indicator (the same way as MACD divergences).

The following illustration show abstract (typical) picture of the readings of StochasticOscillator. 

Picture 16 Construction of StochasticOscillator indicator at an abstract chart

DeMarker. It is the second indicator of this type, that will be reviewed as an example for our course - the indicator of Thomas R. DeMark (the author of the book "New Science of Technical Analysis"). It works to define if the current maximum of the bar could overcome previous maximum. According to the author, he tried to create an indicator without any typical disadvantages of oscillator indicators and that could identify potential extremums (maximums and minimums).

"Inside" of the indicator following happens. In case when current bar maximum is higher than previous one, their difference (delta) is registered. We will denote it as ∆max. If the current maximum did not become higher than previous one, then ∆max. is equal to zero. And vice versa, if the current bar minimum is lower than previous one, then the difference - delta of minimums is calculated (let it be ∆min)

Then the current indicator value is calculated using the formula:

Where SMA_n – is a simple MA in n-period.

Picture 17 Construction of DeMarker indicator at an abstract chart

Thus the indicator can take values within 0 and 1. The author singles out 0.3 and 0.7 levels. The overbought of the market takes place when the indicator reaches the area higher than 0.7-point. the oversold zone is lower than 0.3-point. In case of finding the indicator in these areas the delay or change in tendency might be expected. The basic signals of this indicators are: 

• The selling signal at the moment of quitting the overbought area (i.e. the line crosses the indicator of 0.7 level top-down).
• The buying signal at the moment of quitting the oversold area (i.e. the line crosses the indicator of 0.3 level bottom-up).

The indicator is built in a separate frame, where you can see trends and patterns of graphic analysis like at the price graph (for example, "head & shoulders", "double top" etc.). The trying of a tendency may also be a separate signal of the indicator. As well as for the other indicators, the divergence with the price may also be tracked by DeMerker.