Technical indicator instruction

What is a Technical Indicator?

A technical indicator is a series of data points that are derived by applying a formula to the price data of a security. Price data includes any combination of the open, high, low or close over a period of time. Some indicators may use only the closing prices, while others incorporate volume and open interest into their formulas. The price data is entered into the formula and a data point is produced.

What does a Technical Indicator Offer?

A technical indicator offers a different perspective from which to analyze the price action. Some, such as moving averages, are derived from simple formulas and the mechanics are relatively easy to understand. Others, such as Stochastics, have complex formulas and require more study to fully understand and appreciate. Regardless of the complexity of the formula, technical indicators can provide unique perspective on the strength and direction of the underlying price action.

A simple moving average is an indicator that calculates the average price of a security over a specified number of periods. If a security is exceptionally volatile, then a moving average will help to smooth the data. A moving average filters out random noise and offers a smoother perspective of the price action. Veritas (VRTS) displays a lot of volatility and an analyst may have difficulty discerning a trend. By applying a 10-day simple moving average to the price action, random fluctuations are smoothed to make it easier to identify a trend.

Why Use Technical Indicators?

Technical Indicators serve three broad functions: to alert, to confirm and to predict.

An indicator can act as an alert to study price action a little more closely. If momentum is waning, it may be a signal to watch for a break of support. Or, if there is a large positive divergence building, it may serve as an alert to watch for a resistance breakout.

Technical indicators can be used to confirm other technical analysis tools. If there is a breakout on the price chart, a corresponding moving average crossover could serve to confirm the breakout. Or, if a stock breaks support, a corresponding low in the On-Balance-Volume (OBV) could serve to confirm the weakness.

Some investors and traders use technical indicators to predict the direction of future prices.