Know the Limitation of These Technical Indicators!

Know the Limitation of These Technical Indicators!

By Ahmad A Hassam

The number of technical indicators that are now available in technical analysis is huge and large. Now every trader narrows down the list and in the end only trades with two or three technical indicators most of the time. These two or three technical indicators give them a certain comfort level in making trading decisions.

Most of the indicators are lagging. What lagging means is that they use historical data or past data to give a signal. So, most of the time when the signal is given, the market has already moved ahead. So the effectiveness and reliability of lagging indicators is limited. You need to understand this fact. What you need to learn is the strengths and weaknesses of each indicator that you intend to use in your trading. Because, sometimes, the signal generated by the indicator may nor be reliable at all. So blindly taking it as a trading signal may turn out to be foolish later on. But if you know the weaknesses in an indicator and can understand under what conditions this indicator does not work, you will be more safe in your trading. Now, let’s discuss a few broad categories of technical indicators:

Average Based Indicators: Average based technical indicators are the most simple to use. These average based indicators are widely used by traders in almost all markets whether it be stocks, forex, futures, options, commodities and others. The average is calculated on the past data depending on the time frame chosen by the trader. This is a typical lagging indicator that trails the market. This indicator cannot look ahead and anticipate. So, you need to use it in conjunction with other indicators. A combination of lagging and leading indicators can give highly effective signals. But always keep this in mind, there will always be some room for error with these indicators.

Fibonacci Based Indicators; These indicators are very popular and are being used widely by all sorts of traders in their trading. These are real leading indicators that can look ahead of the price action and anticipate the new direction of the market. Fibonacci Retracements, Fibonacci Extensions and Fibonacci Projections that the three type of indicators that are used widely by traders. But even this is an art. Some trader become experts in making sense out of the Fibonacci levels otherwise never learn how to master these indicators. Combination of Fibonacci and Pivot Point Trading can be very powerful. Now, when a lot of people start using the same thing. Markets tend to reflect that thing and it looks as if the markets also do believe in such things after all. Just remember, markets are just people buying and selling. These overbought and oversold levels are just the reflection of the emotions that people show in their trading. So, markets also believe in what you believe!

Trend Based Technical Indicators; Trend based indicator is one of the simplest. It is formed by drawing a line that connects the high highs in the price action if it is in an uptrend or the low lows in the downtrend. Trendlines can give you an important clue as to the support and resistance. There is something even more accurate than the trendline. It is the trend wall. You need to know all this stuff if you are really serious about learning trading.

Chart Patterns: There a number of chart patterns like the rectangles, triangles, flags, parallelograms and other that are also used as indicators. Most of them are however inaccurate when used solely. You need to learn how to use them in conjunction with other indicators if you want to rely on them in your trading decisions.

Divergence Based Technical Indicators: Divergence based technical indicators are highly popular and to tell you the truth quite reliable if you used them in conjunction with other indicators.

Learn technical analysis and master these indicators if you really want to become a master trader. Most of these indicators when used with caution can give winning trades. Combination of lagging and leading indicators is the best!

Mr. Ahmad Hassam has done Masters from Harvard. Try this 1500 pips Strignano’s Forex Signal Service and know what is the Secret of the 7 Bridges and the Setti Ponti System. Learn forex trading from Tom Strignano. an EX CHIEF CURRENCY TRADER, a real pro and start trading like pros! Learn Fibonacci Retracement!

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Williams %R Indicator – Another Excellent Technical Trading Tool – by Mike Estrey

Many stockmarket technical analysts and chart watchers use the well known Relative Strength Index (RSI) as a reliable overbought/oversold indicator, but there are various other highly useful tools out there, and an excellent and simple one is the Williams Percent Range technical indicator.

This was developed by Larry Williams, an expert in trading and systems analysis, and is a slightly different way of evaluating overbought and oversold market conditions. As with the RSI the %R always falls between a value of 100 and 0 (it is actually calculated as a negative figure in some software systems), and two horizontal lines can normally be defaulted to represent the -20% and -80% overbought and oversold levels. RSI watchers often use 30 and 70 as the equivalent levels, but these are not set in stone for either indicator.

The Williams %R formula

The Williams %R indicator uses highs and lows within its calculation, so this is a bonus, and it is inverted by multiplying it by -100 to give the ‘low’ and ‘high’ figures.

The formula which is preset on most software systems is:

((Highest high value (High, Number of periods chosen) – Close)/(Highest high value (High, number of periods chosen) – Lowest low value (Low, Number of periods chosen))) * -100

Williams’ original analysis focused on 10 trading days as the number of periods chosen to determine a market’s trading range, and then the calculation was made by reference to where the current day’s closing price fell within that range.

There are some similarities with another well known indicator, the Stochastic, (which can be used both as a trend indicator or an overbought/oversold measure), but the Williams %R does not have any smoothing (or fast and slow lines if you like)

A value of 0% on the Williams %R shows that the closing price is the same as the period high, but often the indicator will remain very close to 0% for days on end in a strong bull move where the closing prices are near to period highs. A value of -100% shows that the closing price is identical to the period low, and the opposite scenario is common here.

What this indicator really does that is very good is to show the difference between the period high and today’s closing price within the trading range of the specified number of periods chosen.

It tends to work best in trending markets, and just as with the RSI it is possible to look for divergences between the %R and underlying price movements.

What length of time period to use

Although the indicator was developed on a ten day period length, many software systems now use a 14 day default (same as the RSI). As with all technical analysis, there are no hard and fast rules, and the shorter the period chosen the more volatile the outcome. To achieve less whipsaw action, it is best to use a wider periods range, but this of course results in less signals.

Original trading rules

Larry Williams set the following original trading rules for the indicator:

1 Buy when %R reaches -100%, and five trading days have passed since -100% was last reached, and after which the %R again falls below -85/95%.

2 Sell when %R reaches 0%, and five trading days have passed since 0% was last reached, and after which the Williams %R again rises to about -15/5%.

Some technical analysts simply suggest selling when %R reaches -20% or lower, an overbought level, and buying if it goes below -80%. This is too simplistic, and CFD trades will know that using any overbought/oversold indicator in such a standalone manner is doomed to failure.

The reason is that especially on a trading range breakout, a new trend can immediately become highly overbought and remain so for a long time. The same goes with a big fall (say following a profits warning) which can see a share remaining oversold for a long time while the price continues to trend down – you do not want to be buying then!

It is therefore best, as with all these types of indicators, to wait for the underlying price to change direction before going with the trade. You could quite easily combine the Williams %R with a MACD or TEMA indicator to give you more comfort that you are trading with the trend.

About the Author:

Mike Estrey is the Head of Research for Blue Index, the Day Trading specialists in Contracts for Difference. Foreign Exchange Trading also forms part of their extensive services.

Technical Trading of Stocks

These days, a lot of folks turn toward technical indicators and oscillators to trade stocks instead of looking solely at the fundamentals of a company and its stock. With this type of trading, you are looking for trends on charts and graphs that signal a buy or sell of a particular stock.

There are general groups of technical indicators that can assist in helping you form an opinion on buying and selling stock, options or forex. They are as follows:

  • Trend Analysis – Looking at short and long-term trends to find points where it crosses over the long-term averages.
  • Pattern Analysis – Looking for such things on the charts such as a head and shoulders pattern, triangle patterns, pennants, etc.
  • Trading Ranges – Looking at support and resistance lines and seeking a breakout from the pattern.
  • Relative Strength Index (RSI) – Looking at a stock’s performance recently compared to its historical strength. With this you are looking for overbought or oversold conditions which might suggest a reversal of the trend.

A good place to start reading an introduction on technical indicators and oscillators would be at StockCharts.com with the article: Introduction to Technical Indicators and Oscillators.

For a list of some of the more popular overlays and indicators in use and links to more in-depth information in each, you can look at StockCharts.com at the page: Technical Indicators and Overlays.

Then there is a good article that’s should be a guide for people new to technical trading. This comes from John Murphy, currently with StockCharts.com. He was the technical analyst for CNBC show called Tech Talk. He’s also authored several books on the subject such as “Technical Analysis of the Financial Markets“. You can read up on his laws for technical trading at: John Murphy’s Ten Laws of Technical Trading.

I hope reading through these resources will help give you a better sense of technical trading and help you decide if it’s something for you. At the very least, it’s something you can study and chart on paper for a while and see what works best for you.

If you have a favorite indicator or oscillator that you use and think others would find it very useful, please share more info with us in the comments section.