A hybrid indicator is an indicator used by technical stock analysts and traders, which is comprised of two or more unique indicators. An indicator is simply a statistic used in the analysis of financial instruments that tells investors something important about a security.
Hybrid indicators are an important tool for investors who engage in technical analysis of stocks. Technical analysis is the practice of using past data on stock prices and the volume at which stocks are traded to predict future movements in a stock price. Technical analysis is engaged in based on the principle that all important, public information about a company’s performance is near instantaneously incorporated into the price of the stock, making it almost impossible to actually buy a fundamentally undervalued stock or to short sell a fundamentally overvalued stock.
One example of a popular hybrid indicator used by technical traders is the Moving Average Convergence Divergence indicator, or MACD. The Moving Average Convergence Divergence indicator combines three unique indicators: the 26-day exponential moving average (EMA), 12-day exponential moving average, and the nine-day exponential moving average. The MACD is derived by subtracting the 12-day moving average from the 26-day exponential moving average. Once this trendline is derived, a technical trader will plot this metric on a graph along with the nine-day exponential moving average. When this new Moving Average Convergence Divergence indicator is plotted against the nine-day moving average, traders will use the crossover points of the two trend lines to understand the best times to grow or reduce a position in a certain stock.
Hybrid indicators give technical traders more granular understanding of the movement of stock prices, especially in sideways markets, when there isn’t a strong, broad market trend towards higher or lower prices. In such a market, stocks will typically trade in a band that represents the bounds of the market’s thinking about a company, based on information about the business model that is mostly unchanged. On days when the market is optimistic, a stock may trade higher, and on days when it is pessimistic, it will trade lower, but most of the time there will be no dramatic reevaluations of a stock’s fundamental worth. Hybrid indicators allow traders to gauge inflection points in the market’s attitude toward a stock, allowing them to time their trades to maximize profits. By buying a stock when the market is about to become more optimistic, a trader can ride that wave of optimism and then sell the stock before sentiment turns negative.