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Indicator

Ratio analysis is the quantitative analysis of financial information from a company’s financial statements or share price. Ratios are key to financial analysis, as they provide input for evaluating and comparing a company to its peers, or to an industry ...


Definition of "Indicator"

Statistics used to measure current conditions as well as to forecast financial or economic trends. Indicators are used extensively in technical analysis to predict changes in stock trends or price patterns. In fundamental analysis, economic indicators that quantify current economic and industry conditions are used to provide insight into the future profitability potential of public companies.



Investopedia Explains "Indicator"

In the context of technical analysis, an indicator is a mathematical calculation based on a securities price and/or volume. The result is used to predict future prices. Common technical analysis indicators are the moving average convergence-divergence (MACD) indicator and the relative strength index (RSI).

In an economic context, an indicator could be a measure such as the unemployment rate, which can be used to predict future economic trends. Common general economic indicators are the unemployment rate, new housing starts and the consumer price index (CPI).



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Ratio Analysis

Ratio analysis is the quantitative analysis of financial information from a company’s financial statements or share price. Ratios are key to financial analysis, as they provide input for evaluating and comparing a company to its peers, or to an industry benchmark. 

Ratios provide the vital signs used to measure corporate health, allowing investors to drill down to specific aspects of the company’s operational status.  For instance, the company may be profitable, but certain ratios could indicate that it doesn't manage inventory well, or that it has cash flow issues. 

Financial ratios fall into different categories depending on the parameter being measured:

1. Activity or efficiency ratios: These measure how efficiently a company's day to day operations are managing inventory, selling and producing products, or using assets to generate revenue. Examples include: Inventory Turnover (Cost of Sales / Inventory) and Working Capital Turnover (Net Sales / Working Capital).

2. Liquidity Ratios: These measure the flexibility of a company to pay their short term obligations. Examples include: the Current Ratio (Current Assets / Current Liabilities) and the Quick Ratio (Current Assets - Inventory) / Current Liabilities.

3. Solvency Ratios: These measure the flexibility of a company to pay long term obligations and their level of debt. Examples include: the Debt ratio (Total Debt / Total Assets) and the Financial Leverage Ratio (Total Assets / Total Equity).

4. Profitability ratios: These measure the ability of a company to generate profits and revenue. Examples include: Net Profit Margin (Net Income / Revenue) and Return on Equity (Net income / Equity).

5. Valuation ratios: These are used to value a company's equity, and are often used by analysts to determine if a company is a buy, sell or hold. Examples include: Earnings Per Share (Net Income - Preferred Dividends) / Average Outstanding Shares and the Price-earnings Ratio (Share Price / Earnings Per Share).

 

Ratio analysis is the quantitative analysis of financial information from a company’s financial statements or share price. Ratios are key to financial analysis, ...
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Watch & Learn

This short video series will help you deepen your understanding of Indicator

  1. Ratio Analysis

    Ratio Analysis

  2. Correlation

    Correlation

  3. The Nash Equilibrium

    The Nash Equilibrium

  4. Moving Average

    Moving Average

  5. Trendlines

    Trendlines

  6. Dead Cat Bounce

    Dead Cat Bounce

  7. Trading With The Golden Ratio

    Trading With The Golden Ratio



Frequently Asked Questions About "Indicator"

What are the best indicators for evaluating technology stocks?

Answer:

Technology stocks are often some of the most discussed stocks on the news. Products and services offered by technology companies such as Facebook (FB) and Apple (AAPL) have become ingrained in the daily lives of millions of people. Investors want to spot the company that will roll out the next must-have consumer item or will be indispensable to businesses. Finding which tech stocks is a good bet is a bit more complicated than wandering the aisles of the local gadget retailer.

Tech stocks are most likely going to be considered growth stocks. This type of stock differs from value stocks, which are stocks that are trading for less than their apparent worth. The value of growth stocks, on the other hand, depends on expectations of future growth. Growth investors focus on incremental increases in earnings and revenue rather than dividends, hoping that share prices will increase if earnings/revenues increase even if the company is not profitable. The ultimate goal is capital gains.

There are several strategies available when considering the purchase or sale of a tech stock. Investors can evaluate how company earnings and revenue have changed over time. Did the company see an increase in earnings? No earnings growth should raise a red flag, especially for companies synonymous with having low head counts. How high has the growth rate been? Small companies – valued at less than $400 million – should show double-digit growth, while larger tech companies - $4 billion and up – have relatively lower rates. How long has the growth period lasted? While five years of positive EPS growth is desirable, more years are better.

Other important factors to consider are pre-tax profit margins, which indicate whether management is controlling costs and driving revenue - and return on equity, which shows whether assets are being used effectively. Investors can also look at analyst opinions on the stock, especially when it comes to projected growth. Because these are estimates, investors should take opinions and projected data with caution. Analysts look at the competitive landscape a company is operating in. Fewer competitors, higher barriers to market entry, and company ownership of patents are a few factors that could lead to increased future revenues. 

 



Articles About "Indicator"

The Top Technical Indicators For Options Trading

There are hundreds of technical indicators available which are used by traders according to their style of trading and securities to be traded. This article focuses on a few important technical indicators specific to options trading. (Confused? If you are not sure that technical trading or options is for you, check out or tutorial, Introduction to Stock Trader Types, to decide your preferred style.)

This article assumes familiarity of the reader with options terminology and calculations involved in technical indicators. 

How option trading is different

Usually, technical indicators are used for short term trading. Compared to a typical stock trader, an option trader looks for additional aspects of trading:

  • Range of movement (How much - volatility),
  • Direction of the move (Which way) and
  • Duration of the move (How long - time)

Since options are decaying assets (see time decay of options), the holding period takes significance for options trading. A stock trader has the liberty to hold the position indefinitely or even convert the short term margin leveraged position into a cash based holding. But an option trader is constrained by the limited duration due to the option expiry date where there is no choice to hold an option position indefinitely. It hence becomes important to select the correct trading strategies taking into consideration the timing factor.

Due to the above constraints, almost all of the technical indicators suitable for options trading are momentum indicators, which tend to identify overbought and oversold markets, and hence price reversals and related trends.

The following technical indicators are commonly used for options trading:

  • Relative Strength Index (RSI):

A technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset.

How is RSI useful for option trading?

RSI attempts to determine overbought and oversold conditions of a security. It thereby provides vital indications about the short term price moves, or rather corrections and reversals, once the overbought or oversold condition is identified.

RSI works best for options on individual stocks (instead of indexes), as stocks demonstrate the overbought and oversold condition more frequently as compared to indexes. Options on highly liquid high beta stocks make the best candidates for short term trading based on RSI. (Check out Investopedia’s detailed article on RSI with examples)

rsi

As standard parameters commonly followed, RSI values range from 0-100. A value above 70 indicates overbought levels, and that below 30 indicates oversold.

All options traders are aware of the importance of volatility on options valuation. Bollinger bands capture this aspect of an underlying security, allowing upper and lower ranges to be identified within dynamically generated bands based on recent price moves of the security.

bollinger bands

Two important indications which are derived from Bollinger Bands:

  1. The bands expand and contract as volatility increases or decreases based on the recent price movement of the stock (expansion indicates high volatility and contraction indicate low volatility). The trader can thus take option positions expecting a reversal.
  2. The current market price can be assessed against the current band range for any breakout patterns. Breakout above top band indicates overbought market, which is ideal indication for buying puts or shorting calls. Breakout below lower band indicates oversold market – an opportunity to buy calls or short puts at lower volatility. Care should be taken to assess volatility – shorting options at high volatility is beneficial, as it gives higher premiums to the trader, while buying options at lower volatility provides cheaper options.

Traders are free to use their own desired values while looking at Bollinger bands. Commonly followed values are 12 for simple moving average and 2 for standard deviation for top and bottom bands.

  • Intraday Momentum Index (IMI):

For high frequency options traders, the IMI indicator offers a good choice of technical indicator to bet on intraday option trades. It combines the concepts of intraday candlesticks and RSI, thereby providing a suitable range (similar to RSI) for intraday trading by indicating overbought and oversold markets. However, it is important to additionally be aware about the “trendiness” of the price moves, because when there is a strong visible up/down trend, the momentum indicators will frequently show overbought/oversold opportunities. Being aware of the trends, and additionally using IMI, a trader can spot potentials where he can get into a long position in an uptrending market at intermediate intraday corrections and short positions in a downtrend market at intermediate price bumps.

IMI is calculated as follows:

1. If Close > Open: Gains = Gain (n-1) + (Close - Open); Losses = 0

2. If Close < Open: Losses = Loss (n-1) + (Open - Close); Gains = 0

3. Add Gains and Losses for past n chosen periods

4. IMI = 100 x (Gains / (Gains + Losses))

Taking benefits of leverage with option positions, the IMI indicator (combined with a suitable trend following indicator) offers a great technical indicator for options trading.

The formula offers flexibility to traders to use their own desired values for n. Commonly followed resultant values are 70 or higher indicating overbought markets, and 30 or below indicating oversold markets. The interpretation remains similar to RSI discussed above.

 

  • Money Flow Index (MFI):

Adding further to the RSI basket, the MFI is another momentum indicator that combines the price and volume data to identify price trends for a stock. It is also known as volume-weighted RSI.

money flow index

With volume considered into calculations, the MFI indicator provides vital inputs about the amount of capital flowing in and out of a stock over a recent time period (recommended 14 days).

Due to dependency on volume data, MFI indicator is suited for stock based options trading (instead of index based), and fairs better for long duration option trading instead of frequent intraday. Traders look for cases when MFI indicator moves in opposite direction to that of stock price, as this can be a leading indicator to predict a trend reversal.

Commonly followed resultant values for the Money Flow Index are 20 indicating oversold and 80 indicating Overbought.

 

  • Put Call Ratio Indicator (PCR):

The put call ratio indicates the ratio of trading volume of put options to call options. Instead of the absolute value of the Put Call ratio, the changes in its value indicate a change in overall market sentiment.

A high to lower value move indicates a bullish trend, indicating more calls being opted for by the traders, while a low to high value move indicates bearish trend as more puts are of interest in the market.

  • Open Interest (OI):

Open interest indicate the open or unsettled contracts in options. OI does not necessarily indicate any specific uptrend or downtrend, but it does provide indications about the end of a particular trend. Increasing open interest indicates new capital inflow and hence sustainability of the existing up or down trend, while declining open interest indicates an end to the trend.

For options trading where traders look to benefit from short term price moves and trends, OI provides important information beneficial for entering into or squaring off option positions.

OI values, in addition to the traded volume and price movements, are frequently used by option traders. Here is an indicative interpretation for OI and price moves:

Price

Open Interest

Interpretation

Rising

Rising

Market is Strong

Rising

Falling

Market is Weakening

Falling

Rising

Market is Weak

Falling

Falling

Market is Strengthening

 

The Bottom Line

In addition to the above mentioned technical indicators, there are hundreds of other indicators which can be used for trading options (like Stochastic Oscillators, Average True Range, Cumulative tick, moving averages, etc). On top of those, a lot of variations exist with smoothening techniques on resultant values, averaging principals and usage of combinations of various indicators.  An option trader should select the one suiting his or her own trading style and strategy, after carefully examining the mathematical dependencies and calculations.



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