Technical Indicators As you know, technical indicators are an integral part of technical analysis; they extend performance capabilities thanks to computer processing of price values. Nowadays the whole process of value transformation using indicator formulae is performed by a trading terminal and a user only has to choose the values for the indicator. We will give you examples of using them and also describe operating principles of the most useful indicators available in the Meta Trader 4 trading platform. These mt4 indicators are often used by traders in everyday trading. Some indicators can be put on a price chart, for example a moving average – the red line on the price chart.
Some indicators are opened as windows below the price chart for example, Relative Strength Index (RSI).
All indicators can be divided into two groups for convenience in accordance with their purpose:
Trend indicators – indicate the direction of the current trend of price change Price oscillators – detects breaking points in the current trend of price change
For example, an indicator “moving average” is a typical trend indicator and RSI is an oscillator.
Trend Indicators Moving averages (MA) Moving averages (MA) are the most widely used trend indicators. Their combination detects the beginning and end of a trend. The operating principle of this indicator is simple; a moving average averages out price values for a definite time period and displays smoothed values in the form of lines. Depending on the method of averaging out price values, there are four types of moving averages: simple (or mathematical), exponential, smoothed and weighted. We can say that there is practically no difference between the types of moving averages; simple and exponential moving averages are the most widespread ones. An exponential moving average emphasizes the last price value (the last price makes about 18% of the indicator value). Trading tactics for moving averages is simple: when they move up, it is a good time for buying and when they move down, it is a good time for selling. Generally, a combination of moving averages is used, when one of them has a higher averaging period (red line), and another has a lower averaging period (blue line). The cross-points are signals for buying or selling. It also happens quite often that moving averages of a definite period can be a support/resistance for prices during retracements.
Try to find a period when the majority of price retracements “rebound” from a line of a moving average to use moving averages most effectively. You should start to become familiar with the general concept of technical indicators from studying the properties and operating principles of a moving average.
Average Directional Movement Index (ADX) This indicator calculates part of a price corridor for a definite period which goes beyond the scope of the previous one. Calculation and analysis of this shift estimates the ability of buyers and sellers to raise or lower prices during a definite period relative to the borders of the previous one. Using this indicator is based on a simple conclusion: If today’s price maximum is higher than yesterday’s, it means that the majority tends to buy, and today’s price minimum is lower that yesterday’s, it means that the majority tends to sell. Average Directional Movement Index ADX is displayed in a separate window of your terminal and consists of three lines.
Direction lines (dotted lines) point to the trend direction. If a positive direction line (+DI, red dotted line) is above a negative direction line (-DI, blue dotted line), you should buy, and vice versa. The strongest signal for using trend indicators appears when an ADX line (green solid line) grows and rises above the lower direction line. It is a sign of the beginning of a new trend, because the strongest price movements originate from low activity zones.
Parabolic System (SAR) A Parabolic System (SAR) is one of the most successful tools for detecting trends. Its basic advantage in comparison with other trend detection indicators is that the Parabolic System gives a clear guideline for exiting the market and also allows a trader to get rid of trends which lead to nowhere. In addition, the Parabolic System not only takes into account price values but also time. The Parabolic System (SAR) is displayed in the form of dots. Dots are situated under price bars at the ascending trend and above price bars at the descending trend. These dots are the price values near the point where you should close your position.
When a trend begins, prices change slowly as do changes in the Parabolic System. When the market starts giving new maximum or minimum price values, the Parabolic System follows the price movement direction and pulls up the level of exit from the market. This feature of the Parabolic System can protect a trader from doubts and adds a significant amount of discipline to the process of trading: you either make profit or close a position. The Parabolic System shouldn’t be used as an automated system as it gives many false signals on a market without a trend. This indicator produces the best results in combination with other trend indicators. 6 trend indicators are available in the Meta Trader 4 terminal but we will focus on the three indicators described above.
It is important to understand that it’s not the number of indicators but how you use them that distinguishes a successful trader from a beginner. If you learn to understand and interpret signals of these indicators correctly then it won’t be long before you make profit.
Price Oscillators Stochastic Oscillator Stochastic reflects the ability of buyers and sellers to set a closing price of a certain time period on the border of the previous period. Thereby, if buyers cannot “drag” the closing price to the day maximum at rising prices, the value of the stochastic decreases and lines decline, and vice versa.
Red horizontal lines are stochastic levels. Here are their default values: 30 for the lower level and 70 for the upper level. When stochastic lines reach the upper level, it indicates the “overbought” state of the market and when they reach the lower level it indicates the “oversold” state of the market. The notions “overbought” and “oversold” are relative and provide no real data about the number of bought or sold contracts. It is rather a theoretical conclusion as if price frequently closes near the maximum, the demand should be satisfied and prices should be ready to decline. The same rule can be applied to falling prices: if sellers have been ready to scale down prices for a long time, it means that the offer should weaken and the market should start recovering positions. If you’ve decided to be guided by signal lines, be careful as these signals work well on a market without a trend. But when a trend appears, the stochastic quickly goes above the upper border or below the lower border and stays there, providing false signals to sell or buy.
You can easily eliminate this shortcoming by supplementing a chart with a trend indicator like a moving average or an average directional movement index. Pay attention to the minimums and maximums of the stochastic: narrow and not too deep minimums denote weakness of sellers and possible price growth and vice versa.
Relative Strength Index (RSI) This oscillator follows the closing price of time periods; its values change in a range of 0 to 100.
Red horizontal lines are called “reference lines” and identify how much the market is “overbought” and “oversold” using the same logic as the stochastic. You can choose values for reference lines by yourself, following the five percent rule: an indicator line should be behind reference lines for five percent of the time within the last several months. A feature of RSI is that graphical methods analysis are applied to its values. Price figures, trend lines, support and resistance levels work perfectly with RSI. Besides, it often forms graphical analysis figures a bit earlier than price does so it allows a trader to start acting before others.
Moving Average Convergence/Divergence (MACD) This indicator can hardly be called an oscillator as its values are based on values of trend indicators – two moving averages. However, it is classified as oscillator in the Meta Trader 4 terminal.
A MACD histogram shows the distance between two moving averages thus, it shows trader the difference between long-term and short-term price movement directions. The best way is to trade in the direction of the MACD histogram, i.e. if the current pole is higher than the previous one you should look for opportunities to buy and vice versa. Another feature of this indicator is that price peaks often follow peaks of its values. If the MACD histogram reaches a new maximum within two weeks it means that the demand is strong and prices will rise higher and higher. Divergence of this indicator and prices gives the strongest signal in the technical analysis and predicts price movements with higher probability. Divergence is a situation when price maximum or minimum doesn’t correspond to the maximum or minimum of indicator values. Divergence can appear on all oscillators, but divergence of the MACD indicator is the most noteworthy. Divergence is marked by red arrows on the picture above. The left arrow points to the “bullish” divergence showing a price rise and the right arrow points to the “bearish” divergence which shows a price drop. Divergences of the MACD indicator appear rarely, but if you only monitored this signal and controlled risk you would achieve success without using any other tools. Pay attention to the fact that trend indicators shouldn’t be used when the market is in the price “corridor”, and oscillators work badly on trends. The difference between a beginner and an experienced analyst is in the ability to identify the favorable moment for using either oscillators or trend indicators. If you doubt an indicator’s signal there is a rule of thumb for solving many problems: reduce the oscillator’s period and increase the trend indicator period when there is a conflict. It will help you to avoid any traps that may appear on the market.
You will find approximately twenty oscillators in the Meta Trader 4 terminal. You will master them all in time but, like the majority of traders, you will use no more than two or three indicators for everyday trading. Remember: each separate indicator will make you money if you learn to listen to what it is saying to you. MT4 Indicators