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  1. Exploring Oscillators and Indicators: Introduction
  2. Exploring Oscillators and Indicators: Leading And Lagging Indicators
  3. Exploring Oscillators and Indicators: On-Balance Volume
  4. Exploring Oscillators and Indicators: Accumulation/Distribution Line
  5. Exploring Oscillators and Indicators: Average Directional Index
  6. Exploring Oscillators and Indicators: Aroon Indicator
  7. Exploring Oscillators and Indicators: MACD
  8. Exploring Oscillators and Indicators: RSI
  9. Exploring Oscillators and Indicators: Stochastic Oscillator
  10. Exploring Oscillators and Indicators: Market Indicators
  11. Exploring Oscillators and Indicators: Conclusion

Indicators can be separated into two main types - leading and lagging - both differing in what they show users.

Leading Indicators

Leading indicators are those created to precede the price movements of a security giving predictive qualities.

Two of the most well-known leading indicators are the Relative Strength Index (RSI) and the Stochastics Oscillator.

We will cover the RSI indicator in more detail later on in this tutorial, but for now to get an idea of how it can be used as a leading indicator, take a look at the chart of International Business Machines (IBM) shown below. Notice how the RSI indicator shown at the top of the chart is trending upward while the price of the stock was moving lower. Active traders who were able to spot the divergence between the  indicator and the underlying price were able to open a position before the move higher occurred. Entering a position early, or leading a move before others are able to determine what is going on is the primary goal of many who use technical analysis .

The majority of leading indicators are oscillators. This means that these indicators are plotted within a bounded range. The oscillator will fluctuate into overbought and oversold conditions based on set levels based on the specific oscillator.

Note: An example of an oscillator is the RSI, shown above, which varies between zero and 100. A security is traditionally regarded as overvalued when the RSI is above 70 and oversold when the RSI is below 30. In the case of IBM, you can see how overbought and oversold readings would have allowed traders to anticipate major changes in the price of the company’s shares before the rest of the market took notice. 

Lagging Indicators

A lagging indicator is one that follows price movements and has less predictive qualities. The most well-known lagging indicators are the moving averages and Bollinger Bands®. The usefulness of these indicators tends to be lower during non-trending periods but highly useful during trending periods. This is due to the fact that lagging indicators tend to focus more on the trend and produce fewer buy-and-sell signals. This allows the trader to capture more of the trend instead of being forced out of their position based on the volatile nature of the leading indicators.

How Indicators Are Used

The two main ways that indicators are used to form buy and sell signals are through crossovers and divergence.

Crossovers occur when the indicator moves through an important level or a moving average of the indicator. It signals that the trend in the indicator is shifting and that this trend shift will lead to a certain movement in the price of the underlying security.

For example, by taking a look at the chart of Nike Inc. (NKE), you can see that the crossover between the 50-day and 200-day moving averages (shown by the blue circle  was a clear signal of the beginning of a major uptrend. (For more on this topic, check out: How To Use A Moving Average To Buy Stocks)

The second way indicators are used is through divergence, which was shown in the example of IBM above. Divergence occurs when the direction of the price trend and the direction of the indicator trend are moving in the opposite direction. This signals that the direction of the price trend may be weakening as the underlying momentum is changing.

There are two types of divergence - positive and negative. Positive divergence occurs when the indicator is trending upward while the security is trending downward. Positive divergence is the type of divergence shown on the chart of IBM above and is a bullish signal that suggests the underlying momentum is starting to reverse and that traders may soon start to see the result of the change in the price of the security. Negative divergence works in the opposite manner and occurs when an indicator starts to trend lower while the price of the underlying security trends upward. Negative divergence is a popular bearish signal that is used by traders for identifying periods where momentum is weakening during an uptrend.

For example, notice on the chart of Biogen Inc. (BIIB) below, that the relative strength index was trending downward while the security's price was trending upward. This negative divergence would be used to suggest that even though the price was lagging the underlying strength, based on the RSI, traders would still expect to see bears control of the asset's direction and have it conform to the momentum predicted by the indicator.

Indicators that are used in technical analysis provide an extremely useful source of additional information. These indicators help identify momentum, trends, volatility and various other aspects in a security to aid traders when making decisions. It is important to note that while some traders use a single indicator solely for buy and sell signals they are best used in conjunction with price movement, chart patterns, and other indicators. (For related reading, see Technical Analysis Strategies for Beginners)


Exploring Oscillators and Indicators: On-Balance Volume
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