Indicators: an introduction

Before reading this lesson, you should have previously read through:

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What are indicators?

Indicators are a set of tools applied to a trading chart that help make the market more clear.

For example, they can confirm if the market is trending or if the market is ranging.

Indicators can also provide specific market information such as when an asset is overbought or oversold in a range, and due for a reversal.

What do indicators look like?

Indicators can be displayed in two ways:

Chart Indicators

number_1 Indicator shown below the chart
number_2 Indicator shown directly on the chart

Lagging and leading indicators

There are a number of different indicator types, however it is important to first understand that indicators fall into two distinct categories:

  • Lagging – providing signals that confirms the behaviour of the price action
  • Leading – providing signals before the price action happens

Leading indicators

Leading indicators measure the rate of change in the price action and can register when the price action is slowing down or speeding up.

Leading indicators can provide signals ahead of time, while lagging indicators are generally used to confirm the price action, such as the strength of a trend.

For example, if the price action has rapidly risen and then begins to slow, a leading indicator can register this change in momentum and hence provide a signal that the asset may be due for a reversal.

Lagging indicator

A lagging indicator is generally used to confirm what the price action has done, such as whether the price action has entered into a trend and the strength of that trend. They are called lagging indicators because they lag behind the price action.

Types of indicators

Indicators produce trading signals and each indicator does this differently depending on how the indicator calculates the price action to provide the signal. They fall into two further categories:

  • Trending indicators that work best in trending markets
  • Oscillating/ranging indicators that work best in ranging markets

Trending indicators

The trend on a chart, as well as its strength, is not always obvious and a trending indicator can make this clearer. Trending indicators tend to be lagging in nature.

Trending indicators tend to be lagging in nature and are used to identify the strength of a trend, and help find entries and exits in and out of the market.

Trending indicators can therefore enable a trader to:

  • Identify whether the market is in a trend
  • Determine the direction and strength of that trend
  • Help find entries and exits into and out of the market

In the chart below, we use an example of a moving average. When the price is below the moving average, this indicates that the market is in a downtrend.

Moving Average on Chart

Oscillating indicators

When the price is moving in a range, an oscillating indicator helps to determine the upper and lower boundaries of that range by showing whether something is overbought or oversold. They do this by oscillating between an upper level and a lower level. Oscillating indicators tend to be leading in nature.

Oscillating indicators are used in a range, tend to be leading in nature, and determine whether the asset is overbought or oversold.

If an oscillating indicator signals that an instrument is overbought, a trader will be likely to look for short positions. Likewise, if an oscillating indicator signals that an instrument is oversold, a trader will likely looks for long positions.

In the chart below, a stochastic indicator is being used underneath the chart to show changes in buying and selling pressure within a range.

Stochastic below Chart

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When to use trending and oscillating indicators

The type of indicators being used depends on the trading system, and ultimately comes down to the preference of the trader.

The type of indicator you use is up to the trader's preference; however oscillating indicators are useful in ranging markets, while trending indicators are useful in trending markets.

For example, if you prefer to trade in ranging markets, then oscillating indicators, such as the stochastic, commodity channel index or the relative strength index, will be useful to help make trading decisions.

If you prefer to trade in a trending market, then trending indicators, such as the MACD or average directional index, will be more useful.

In the following chart, you can see a combination of an oscillating indicator (stochastic oscillator) and a trending indicator (MACD) to trade in ranging and trending markets, respectively. Combining indicators in practice will be explored further in this lesson.

Combining Indicators

Combining indicators correctly

Combining trending and oscillating indicators to use in different market conditions is beneficial.

Market conditions continually change from ranging to trending and back again, and so you can use each indicator according to its strength.

You can use different indicators for different market conditions

number_1 In a ranging market, the oscillating indicator – stochastic – is more useful
number_2 In a trending market, the trending indicator – moving average – is more useful

Avoid overloading charts

Once it becomes clear how useful indicators can be, there can be a tendency to use too many indicators on one chart. For example, if a trader has added three oscillating indicators below a chart, then there are three indicators providing the same information.

Overloading your Chart

Adding more indicators that supply the same information to a chart will not make them more reliable. They simply show the same overbought and oversold information in different ways, and only take up more space on your chart.

Careful not to use too many indicators directly on the chart and obscure the price action

Summary

So far, you have learned that ...

  • ... indicators are tools that are applied to a price chart to help determine the market conditions
  • ... indicators can be displayed either on the price chart itself, or below in a separate area.
  • ... there are many types of indicators, each with their own purpose and benefit.
  • ... a lagging indicator will confirm the market conditions, whereas a leading indicator can provide trading signals for future price action.
  • ... trending indicators can help determine whether the market has entered into a trend and the strength of that trend.
  • ... oscillating/ranging indicators can help determine when the market is overbought or oversold when the market is ranging.
  • ... indicators can be combined and so that they can be used over different market conditions.
  • ... combining indicators of the same type is ineffective, because they in essence show the same information.
  • ... you should not overload your charts, because too many indicators can give you conflicting signals.

What next?

If you want to start learning about the different indicators then we recommend that you first learn about trending indicators:

Module
Learn what the different types of trending indicators are and how to use them to spot and confirm markets trends.

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  • thanks for the video, very helpful especially for beginners!
  • Thank you for lesson. I just have one question. Isnt't commodity channel index trending indicator? In the headline "When to use trending and oscillating indicators", it's said: "if you prefer to trade in ranging markets, then oscillating indicators, such as the stochastic, commodity channel index or the relative strength index, will be useful to help make trading decisions".
  • Hey,

    The CCI indicator is classed as an oscillator because it shows levels of overbought and oversold assets. Typically, these are used to find cyclical patterns and do well in ranging markets because ranging markets frequently go into periods overbought and over sold territory.

    That is not to say that the CCI cannot be used for trending markets, however, because it oscillates between overbought and oversold, it is classed as an oscillator and so helps you when you are in a ranging market.
  • Hi Dean,

    Thank you for explanation. I got confused because CCI is in MT4 it's set under trend indicators. It's all clear now.
  • Hey, Ah, one thing about MT4, they do have a funny way of classing indicators and its a bit weird sometimes smile. Totally see where you are coming from. But as always, just post as many questions as you like, we are always here to help smile
  • Thank you for explanation
  • Hunnn am very enjoy the explanation, what can will set default settings of those indicators.
  • Great website and training for beginners.

    "In a separate area underneath the price chart such as the and MACD".

    I think a word is missing here: as the xxxx and MACD.
  • Probably meant: such as RSI and MACD.
  • Nice Lesson again! I am slowly starting to see how you can link things together. For example after this lesson i feel like we could include a leading - oscillating indicator in the trading support and resistance strategy to help with deciding whether to enter a trade.
  • Hi SiKWiThIt,

    If you are interested in looking at oscillating indicators in more detail, why not check out the lesson specific to these.

    There are also lessons on strategies, with support and resistance included smile

    As a gold member, you can also access our trading classroom if you wish to discuss any of these with other members, and our experts.

    Regards,
    Emma

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