Technical analysis is used as a way of predicting future stock price movements by studying past trends. It's based on the assumption that "history repeats itself", so prices can be tracked and forecasted using mathematical models and charting techniques.
Technical oscillators use the internal dynamics of market activity (prices, trading volume) to measure buying or selling pressure, or overall investor sentiment within a stock, thus identifying key turning points. RSI (Relative Strength Index) and Stochastics are the two most well-known examples.
Let's look at them in more detail:
Relative strength index (RSI)
As the name suggests, measures relative strength. When it's near 30%-40%, that means overbought; when it's near 0%-20%, that means oversold.
The grey line represents the oscillator itself, an average percentage change in price from one period to another, so it varies with time.
RSI is used mainly on intraday charts but can also be applied to weekly or monthly ones.
The RSI indicator is a popular oscillator that can measure the market's strength and is often used as a momentum indicator.
RSI calculates momentum as changes in price relative to recent price action; an RSI value above 70 shows that price has recently increased (thus indicating bullish momentum), while a value below 30 indicates that the opposite is true (indicating bearish/downward momentum).
On the other hand, Stochastics considers four input parameters:
- Low price,
- high price,
- last price, and
- close-to-close movement.
Remember, it's not the technical oscillators themselves that predict the future but the signals they generate.
So even if a stock is technically "overbought" or "oversold", as long as those conditions haven't been reached recently and there haven't been any strong signals associated with them, it doesn't mean it'll necessarily reverse immediately.
Also, keep in mind that just because a sure indicator may have signalled an impending reversal in a past instance, that doesn't necessarily mean it will work this time around too.
Technical oscillators can be applied to any time frame, but the most popular daily and weekly charts.
They are more of a short-term analysis tool than anything else -- they help traders get an idea about whether the trend is likely to strengthen or weaken over the next several days or weeks.
Many different types of oscillators perform in slightly different ways: one way they differ is in which scale their values fall on.
Simply put, this means that some oscillators use a smaller range of numbers while others use a more extensive range.
In addition to this, some oscillators are more sensitive in certain market aspects. For example, RSI is more responsive in showing overbought and oversold levels when dealing with bullish trends (the market going up).
At the same time, MACD has a much greater ability to pick up momentum changes when dealing with bearish markets where the price is headed down. It means that care must be taken when choosing oscillators for a strategy - you must consider which indicators work best in the current environment!
Different types of oscillators include
Overflow Oscillator | Parabolic Stop and Reversal | Price Oscillator | Fractal Dimension Index | Momentum Oscillator | Volume Oscillator | Vortex Indicator |
Technical oscillators like the Overflow Oscillator and Vortex Indicators can help traders with range trading and breakout strategies.
Technical analysis of those types of indicators can be found at those links and those for momentum oscillators such as the Momentum Oscillator and Parabolic Stop and Reversal, which can work well in trend trading strategies.
Finally, traders may use many other kinds of technical indicators to aid them in their trades; these include volume oscillators such as the Money Flow Index (MFI) and Chaikin Volatility Index (CVIX).
Technical oscillators are very different from lagging indicators or those that only show what has already happened. It makes them much more helpful for traders to predict future market movements.
They can use them in almost every type of strategy. Many traders rely on them daily to help guide their entries, exits and money management techniques because they often provide valuable insight into price action.
Whether it will continue moving in its current direction, how long it may stay there, and when a trend might end!