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Technical analysis involves the inspection of historical price movements to forecast future price action. Technical analysts rely almost exclusively on charts for their analysis. An indicator is a series of data points that are derived by applying a formula to the price data of an underlying (equity, commodity, or index). Market analysts have relatively few basic resources (7) in the form of data sets to work with. These include date, time, open, high, low, close and volume. Price data includes any combination of the open, high, low, close and volume information over a period of time. Many indicators use only the closing prices, while others incorporate volume open interest and close location value into their formulas. The price data is entered into the formula and a data point is produced. Computerized technical indicators calculated on prices move more quickly than the prices themselves, providing a foreshadowing probability, while indicators calculated on indicators move more quickly than the original indicator, providing an even faster probability factor.
Lagging (following) Indicators are trend-following indicators (with longer time periods) that work with a high accuracy probability when the underlying develops strong trends. Following indicators are calculated to have traders enter and remain in a position as long as the trend continues. Following or lagging indicators are not efficient in trading ranges (where the market is moving up and down) and respond so slowly that the indicator will not call an early entry of a move or indicate a timely profitable exit.
Nearly every technical indicator is a following indicator. Simple and exponential moving averages, Stochastic, average directional indicators are following (lagging) indicators because they follow (or lag behind) the prices and the indicator will only offer a buy or sell signal later in the move. A following or lagging indicator is like a starting bell sounding one minute after the race horses have left the start gate. Following or lagging indicators only have a high profit probability in strongly trending markets.
Leading indicators provide an early high probability where the underlying might establish or break support and resistance. Leading indicators (usually with shorter time frames) are designed to lead prices rather than follow them. Most leading indicators represent a form of price momentum over a short fixed look-back period, which is the number of periods used to calculate the indicator. Momentum measures the rate-of-change of the underlying so that as the price rises, price momentum increases. Leading indicators may give false early signals for entry and untrue exit signals as the indicator may be too sensitive and react too quickly.
(Chart of IBM below from DDPlus- Disnatdirect).
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For more information on high profit potential with low pre-determined risk indicator selection, visit www.tamm2000.com * for an outline of excellent, reasonable, available on-line courses. Traders should educate themselves by investing in classes or be compelled to pay a much higher tuition through losses.
Future articles will cover candlestick trading, support and resistance and indicator selection.
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