A GUIDE TO

WL INDICATORS
GETTING TECHNICAL ABOUT TRADING: USING EIGHT COMMON INDICATORS How is it different from other MAs?
TO MAKE SENSE OF TRADING While other MA calculations may weigh price or time frame differently, the SMA is calculated by
weighing the closing prices equally.
What’s a technical indicator and why should I use them? Traders usually use more than one SMA to determine market momentum; when an SMA with a
What’s the market going to do next? It’ss a question that’s almost always on traders’ minds. Over short- term time period (for instance, a 15-day SMA) crosses above an SMA with a long-term time
time, traders have looked at price movements on charts and struggled to make sense of the ups, frame (a 50-day SMA), it usually means that the market is in an uptrend.
downs, and sometimes sideways movements of a particular market. When an SMA with a shorter time period crosses below an SMA with a longer time period, it
That’s given rise to technical indicators – a set of tools that use the real-time market moves of an usually means that the market is in a downtrend. Traders also use SMAs to detect areas of
instrument to give traders a sense of what the market will do next. There are hundreds of different support when a trend changes direction. Generally, an SMA with a longer time period identifies a
indicators that traders can use, but whether you’re a new trader or an old hand at it, you need to stronger level of support.
know how to pick one, how to adjust its settings, and when to act on its signals.
In this guide, we’ll show you how you might improve your trading prowess with eight of the most
commonly used indicators. We’ll also show you five mistakes to avoid when using technical
indicators.

Calculation
SMA = Average of all closing prices across a set number of periods
Chart above depicts period = 15

Simple Moving Average Crossover

The graph displays two Simple Moving Averages to form a Simple Moving Average crossover.
After price moves like this, what do you think the market will do?
Moving Average (MA)
A Moving Average (MA) combines the price of an instrument over a particular time frame and
divides by the time frame to smooth price moves into a single trend line.
Traders use these to reduce the noise that price sometimes causes and identify patterns in the
price moves when the market is volatile. Moving averages are often utilissed to determine the
trend in volatile markets.
There are many types of MAs and traders typically use more than one to determine market
momentum. The most popular are the Simple Moving Average (SMA) or the Exponential Moving
Average (EMA).

There are many types of MAs and traders typically use more than one to determine market The circle represents the cross of the shorter, 15-period SMA over the longer, 50-period SMA.
momentum.

Simple Moving Average (SMA) Exponential Moving Average (EMA)

A simple moving average (SMA) combines the closing prices of an instrument over a specific time Like the SMA, Exponential Moving Average (EMA) combines the closing prices of an instrument
frame and averages that value by the number of time frames. over a specific time frame and averages that value by the number of time frames. With EMAs,
however, the calculation gives more weight to the most recent prices.
How is it used? The MACD is shown in a chart below the normal one. It also displays a histogram, which
represents the difference between the MACD and the signal lines.
Exponential Moving Average Crossover
If prices change, EMAs generally react more quickly than other moving averages. That’s one of With the MACD, traders watch for several types of movements.
the reasons why it’s used to create other indicators, like the Moving Average Convergence • MACD lines crossing the signal line:
Divergence (MACD). Some short-term traders use 12- and 26-day EMAs, while long-term Most traders see the MACD line cross over the signal line as a signal to buy while a drop
traders prefer to use 50- and 200-day EMAs. below the signal line is seen as a sign to sell. No matter what the signal, traders often wait
for a con- firmed cross before placing a trade.
• The MACD line moving away from price movements:
When price movements diverge away from the MACD line, traders typically view this as the
end of the current trend.
• The 12-day EMA diverges from the 26-day EMA:
When the MACD rises suddenly, traders see this as a sign that the instrument is gaining
momentum.
• Movement above or below the zero line:
Many traders use the zero line to detect possible support or resistance levels. If the MACD rises
above zero, this means the 12-day EMA is above the 26-day EMA. Traders view this as a sign that
the instrument is in an uptrend. Conversely, if the MACD drops below zero, this means the 12-day
EMA is below the 26-day EMA. Traders see this as a sign that the instrument is in a downtrend.

Calculation
EMA = Average of all closing prices across set number of periods*
*EMA is weighted by most recent
prices Chart above depicts period = 25

The graph displays two exponential moving averages. This is used as an EMA crossover above or
used to create other indicators such as the MACD.

1. MACD crosses below the signal line, indicating a potential sell trade.
2. MACD crosses above signal line, pointing to a buy opportunity.
3. Cross above zero confirms a buy trade.

The circle represents the cross of the shorter, 25-period EMA over the longer, 50-period EMA.

Moving Average Convergence Divergence (MACD)

The Moving Average Convergence Divergence (MACD) helps traders forecast when to enter or exit a
trade. Based on the Exponential Moving Average (EMA) indicator, this trend-following indicator can
also be used to determine the underlying momentum behind a trend.
The MACD is calculated by subtracting the value of a fast, 12-day EMA from the value of a slow, 26-
day EMA. This value is compared to a nine-day EMA of the MACD, which is displayed as a signal line.
Commodity Channel Index (CCI)
The Commodity Channel Index is an oscillator that helps traders forecast when a currency pair is
overbought or oversold based on cyclical price movements.
CCI compares the current price change with the average price change.

TPx is the typical price for the time period. For example, if you wanted a CCI of 14 days, the time
If the difference between these two values is positive, it shows that the market moves are period would be 14 days. X is the time period. You’ll use this to calculate the average.
strengthening. That’s because prices are above the average. If the difference is negative, it shows
that the market moves are weakening because prices are below the average.
Many applications calculate CCI automatically; for example, when you first open the indicator in
the DealBook® platform, the CCI is set to 14 days.
If you’re interested in knowing how CCI is calculated, you can use the following calculation:

TPx is the typical price for the time period.

SMA TP is the moving average of the typical price for the time period. X is the time period.
Relative Strength Index (RSI) Stochastic Oscillator
The Relative Strength Index (RSI) is a technical indicator that shows when a financial product is The Stochastic Oscillator compares the closing price of an instrument to its price over a certain
overbought or oversold. Traders use this to determine when to enter or exit a position. period of time. Traders use this to measure the momentum of a trend as well as determine when
it may reverse its course. They can then forecast possible entry or exit points.
RSI compares the average number of days that an instrument closes up to the average number
of days that it closes down. This average is then rated on a scale of 1 to 100.

The Stochastic Oscillator measures whether an instrument is overbought or oversold by analysing

how long it can maintain the trend. This uses two lines: the %K and %D which appear on a sub-chart
below the price chart.
• The %K line compares the market close for the day to the trading range over 14 days.
Traders can calculate it manually using the following formula.
• The %D line is a signal line which uses a simple 5-day Simple Moving Average (SMA) of the
%K. This can be calculated as:
%K = 100[(C - L14)/(H14 - L14)]
C = The most recent closing price.
L14 = The low of the 14 previous trading sessions.
RS = Average of x days when the instrument closed up/ Average of x days when the instrument
closed down. H14 = The highest price traded during the same 14-day period.
Typically, RSI is used with a 9-, 14-, or 25-calendar day (7-, 10-, or 20-trading day) period against %D = 5-period moving average of %K.
the closing price of an instrument. If you add more days to the calculation, the value is considered Traders monitor the oscillator as it moves between a range of zero and 100. They consider the
less volatile. instrument oversold when the %K or %D moves below 20 and overbought when the %K or %D
Traders monitor the RSI value, considering the instrument overbought when its price goes above moves over 80. When the %K line crosses the %D, many traders consider this to be a good place
to buy and when the %D crosses the %K, it is a good place to sell.
the 70 baseline and oversold when its price drops below 30 baseline.
Traders using the RSI indicator should use it with other indicators. Sudden surges or drops in the
price of an instrument can create inaccurate buy or sell signals.
Bollinger Bands
Bollinger Bands forecast the potential high and low prices for an instrument relative to the moving
average. They also help traders visualise volatility and determine when a trend may continue or
When price moves are close to When price moves are close to When price movements closely
reverse.
the Upper Band, the current the Lower Band, the current follow the Middle Band,
price of the instrument is price is considered low relative traders consider the
considered high relative to to recent prices. If they cross instrument to be trading within
recent prices. If they cross the the Lower Band, traders its average.
Upper Band, traders consider consider the instrument to be
the instrument to be oversold.
overbought.

Parabolic SAR (PSAR)

The Parabolic SAR (PSAR) indicator looks at the relationship between the price and time of an
instrument. Traders use this to determine the short-term momentum of the instrument and
forecast where to place stop orders.
Unlike the indicators previously discussed, the PSAR is useful when you are already in a position.
SAR stands for stop and reversal. That’s why many traders close their current position and open
a new position in the opposite direction once the market reaches the PSAR. Traders may also use
PSAR to determine stop points.
Bollinger Bands consist of three bands: When charted, the PSAR pattern appears as a series of points placed above or below the price;
• THE MIDDLE BAND is calculated on the average price of an instrument over a specific time traders frequently describe the pattern as a parabola or French curve. The placement of the
period. points de- pends on the direction of the market movement. In an uptrend, the point is placed
• THE UPPER BAND uses the Middle Band plus two standard deviations; a standard deviation below the price. In a downtrend, the point is placed above the price. Often, traders monitor the
measures how close prices are to the average. position of the points; if they change, traders often decide to enter or exit the market.
• THE LOWER BAND also uses the Middle Band, minus two standard deviations. Like the RSI, traders using the PSAR should use it with other indicators. Sometimes, using the
points to forecast direction can be difficult and lead to traders entering or exiting a position
During normal market conditions, the bands usually appear to move in a synchronous pattern, but
prematurely. Many traders will choose to place their stop loss orders at the PSAR value
you can use them to view market volatility.
because a move beyond this will signal a reversal, causing the trader to anticipate a move in the
1. If the distance between the bands is tight, it indicates low volatility in the market. opposite direction.
2. If the distance between the bands is wide, it shows high volatility in the market.
When price movements closely follow the middle band, traders consider the instrument to be
trading within its average.
These bands are continually changing based on the real-time price movements of the instrument.
Traders read the bands in a number of different ways.
When the parabolic line appears underneath the price moves, the market is in an uptrend. With too many indicators, it’s hard to tell exactly what the market is doing.
When the line appears above the price moves, it indicates a downtrend.
Some traders look to keep their stops beyond the Parabolic Lines.

Top 5 Indicator Trading Errors

Now that you know a little bit about all of these indicators, let’s look at some common mistakes
that newer traders make when applying them.

1. Using Overbought/Oversold Indicators Incorrectly in Trending Markets

One of the most common errors that newer traders make when using overbought/oversold
oscillators, such as Stochastics or RSI, is to automatically buy oversold or sell overbought
markets. What many new traders don’t realise is that prices can remain overbought or oversold for
a long period of time in strongly trending markets; indeed, the fact that a certain market is trending
implicitly implies that the trade is primarily in only one direction. For this reason,
overbought/oversold oscillators are best used in range-bound environments, when there is no
clear trend.
Is the market overbought? Or the continuation of an uptrend?

This trader is using four indicators in their chart: Bollinger Bands, the MACD, the RSI, and the Slow
Stochastic. Not only is this trader getting duplicate information, this many indicators makes the
chart hard to read.

3. Interpreting Indicator Signals Before a Candle Closes

Most indicators adjust in real-time to current market prices. On the surface, this sounds very
logical. What few traders realise is that this process can lead to false signals when prices
reverse within a given time period. For example, a drop in price during the morning may push
the daily RSI out of the overbought area (typically, this is defined as above 80) down to 78,
While the price moves have hit the top Bollinger Band, it doesn’t necessarily mean that it is a prompting a trader to take a short position. If prices reverse and rally to new highs later that
good time to sell. Markets can remain overbought for a long period of time, so traders may want day, not only will the trade likely be stopped out, but the RSI may rise back above 80 line,
to look for other signs to confirm a sell trade. invalidating the reason for taking the trade in the first place. Traders should exercise caution
when interpreting indicators before the relevant time period elapses.
2. Assuming More Indicators are Always Better
Another common mistake that many traders, including myself, make at one point is assuming
that using more indicators is always preferable. In trading, unlike many other endeavours,
additional information often leads to conflicting signals and confusion rather than clarity. This is
the essence of the old trading adage, “Over-analysis leads to paralysis.”
Another knock against using multiple indicators is that many tools tell traders the same thing (in
statistical jargon, this is called multicollinearity). If a currency pair is oversold on the 14-period
RSI, it is also likely to be oversold on the Stochastic Oscillator, which cover roughly the same
time period. Combining these two indicators is unlikely to give the trader any additional insight
and may actually obscure the true state of the market. In general, we encourage traders to focus
on only two or three indicators that isolate different aspects of the market and complement each If a trader had made a decision based on the incomplete candle, they may have missed this buy
other well. For instance, traders may want to combine an overbought/oversold indicator, a trend opportunity.
indicator, and a momentum indicator to gain a broad-based perspective of the market.
4. Failing to Consider the Reliability vs. Timeliness Tradeoff
All modern trading programs allow traders to adjust the default settings of different indicators.
This capability allows traders to tailor specific indicators to their chosen time frame and
preferences. In all cases, increasing the sensitivity of an indicator (by reducing the time period,
for instance) leads to earlier signals, but those signals by definition become less reliable.
Conversely, decreasing an indicator’s sensitivity will yield more reliable, but less timely
indicators. Each trader must determine the ideal settings for his or her own trading, considering
the unavoidable trade offtradeoff between reliability and timeliness.

While indicator settings can be modified, adjusting the parameters can impact how the indicator
reacts to the market.

5. Assuming the Latest Indicator is the ‘“Holy Grail’”

The most important thing to remember when using indicators is that they’re all simply
derivatives of price (and/or volume in some markets). Most of the reliable and logical indicators
have already been created, and in an attempt to create new indicators, many analysts stray
further and further away from price action. Never forget that traders make money by buying
assets low and selling them high; all indicators should be interpreted with consideration to what
they are implying about underlying price action.

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