10. Technical indicators
Summary
TLDRIn this informative video, Pritik Singh introduces various trading indicators, explaining their significance in quantitative analysis and ease of use. He covers overlay and underlay indicators, focusing on popular ones like the moving average, MACD, and RSI. Singh uses cricket analogies to clarify moving averages, discusses the MACD's reliability in momentum detection, and highlights the RSI's role in identifying overbought and oversold conditions. The video aims to enhance viewers' understanding of these tools for better trading decisions.
Takeaways
- 📊 Indicators are popular in the trading community for their quantitative nature and ease of use, allowing traders to make decisions based on numerical data displayed on their screens.
- 📈 Indicators are derived from price and help assess market conditions such as overbought/oversold states, momentum, and proximity to average prices.
- 🔍 There are two types of indicators: overlay indicators that appear on the price chart itself (e.g., Bollinger Bands, Moving Averages) and underlay indicators that appear in a separate pane below the price chart (e.g., RSI, MACD).
- 🔢 Oscillators like RSI and MACD have a range from 0 to 100 and are used to identify overbought and oversold conditions, as well as momentum changes.
- 🏏 The moving average is a running average over a set period, useful for smoothing out price data and identifying trends, with the option to adjust the period for different levels of detail.
- 🌐 Exponential Moving Average (EMA) gives more weight to recent price movements, reacting more quickly to new data compared to a Simple Moving Average (SMA).
- 📈 The direction of a stock's trend can be inferred from its position relative to a moving average, with prices generally above indicating a bullish market and below indicating a bearish market.
- 🔄 Moving Average Convergence Divergence (MACD) is a momentum indicator that uses the difference between two EMAs to signal changes in trend direction and strength.
- 📊 RSI (Relative Strength Index) is a leading momentum indicator that compares a stock's performance to itself over a set period, indicating overbought or oversold conditions.
- ⚠️ RSI can sometimes be 'sticky,' where it remains at extreme values for extended periods without indicating an immediate trend reversal.
- 📚 For further learning, the script suggests visiting the varsity post for more information on additional indicators such as Bollinger Bands and ATR (Average True Range).
Q & A
What are indicators in the context of trading?
-Indicators are tools used in trading that are based on quantitative calculations derived from price data, helping traders make decisions by providing visual representations of market conditions such as overbought or oversold states, momentum, and average price levels.
Why are indicators popular among traders?
-Indicators are popular because they are quantitative, allowing traders to see numerical values on their screens to make decisions, and they are easy to plot thanks to modern charting platforms that perform the calculations automatically.
What is the difference between an overlay indicator and an underlay indicator?
-An overlay indicator is plotted directly on the price chart, like Bollinger Bands or a Moving Average, while an underlay indicator is displayed in a separate pane below the price chart, such as RSI or MACD.
What is an oscillator and how does it work?
-An oscillator is a type of indicator that fluctuates between a minimum and maximum value, typically 0 and 100. It is used to identify overbought and oversold conditions in the market, as well as to measure momentum.
Can you explain the concept of a moving average using the cricket analogy provided in the script?
-The cricket analogy compares a moving average to the average runs scored by a batsman over a series of matches. As new matches are played, the oldest match's runs are dropped, and the average is recalculated with the most recent matches, reflecting a 'moving' average that adapts to recent performance.
What is the purpose of a moving average in trading?
-A moving average smooths out price data over a selected period, providing a baseline or average level that helps traders identify trends, such as whether the market is in an uptrend or downtrend, by observing the price's relation to the moving average line.
How does an exponential moving average (EMA) differ from a simple moving average (SMA)?
-An exponential moving average gives more weight to recent data points, making it more responsive to recent price changes compared to a simple moving average, which assigns equal weight to all data points in the selected period.
What is the Moving Average Convergence Divergence (MACD) indicator and what does it measure?
-The MACD is a momentum indicator that shows the relationship between two moving averages, typically the 12-day and 26-day EMAs. It measures the difference between these EMAs and can indicate trend direction and strength, as well as potential trend reversals.
What is the RSI (Relative Strength Index) and how is it used in trading?
-The RSI is a leading momentum indicator that compares gains and losses over a period of time to determine the strength of a trend relative to itself. It oscillates between 0 and 100, with common overbought and oversold thresholds at 70 and 30, respectively.
What is the issue of 'stickiness' in the context of the RSI indicator?
-Stickiness refers to the situation where the RSI remains at extreme levels (near 100 for overbought or near 0 for oversold) for an extended period without the expected price retracement, indicating that the indicator may not always correctly predict trend reversals.
What are some key takeaways from the video script regarding the use of indicators in trading?
-The key takeaways include understanding that indicators are quantitative and easy to use, recognizing the difference between overlay and underlay indicators, knowing how to interpret oscillators, and learning how to apply moving averages, EMAs, MACD, and RSI to analyze market trends and potential reversals.
Outlines
📈 Introduction to Trading Indicators
The video script begins with an introduction to trading indicators by Pritik Singh. He explains that indicators are popular due to their quantitative nature and ease of use, as they are calculated by charting platforms post-internet advent. Indicators are derived from price hypotheses and help traders understand market conditions such as overbought or oversold states, momentum, and proximity to average prices. The script differentiates between overlay indicators, which appear on the price chart, and underlay indicators, which are on a separate pane. It also introduces the concept of oscillators, which are indicators that fluctuate between 0 and 100, indicating overbought and oversold areas.
🏏 The Moving Average in Trading Analogy
The script uses a cricket analogy to explain the concept of a moving average, comparing it to a running average of a batsman's scores over a series of matches. It illustrates how a five-match average is recalculated by dropping the oldest match and including the newest, thus 'moving' the average. This concept is then applied to stocks, where closing prices are used to calculate daily moving averages of varying periods. The script also demonstrates how moving averages appear on a chart, serving as a baseline to understand price trends and volatility, with shorter periods providing more detail and longer periods offering a smoother line.
📊 Exponential Moving Averages and Their Significance
The script introduces Exponential Moving Averages (EMA), emphasizing their ability to weigh recent price movements more heavily than older ones, making them more responsive to current market trends. It contrasts EMA with Simple Moving Averages (SMA), showing how EMA reacts faster to market changes. The video script discusses the use of moving averages to identify uptrends and downtrends, suggesting that longer periods like 100 or 200 days are more reliable for trend analysis. It also introduces the concept of using multiple moving averages to compare different time frames and identify potential trend changes.
🌐 Understanding MACD for Momentum Trading
The script explains the Moving Average Convergence Divergence (MACD) indicator, developed by Gerald Appel in the late 70s, as a reliable momentum indicator. It details how MACD is calculated by subtracting a 26-day EMA from a 12-day EMA, creating a MACD line that indicates upward or downward momentum. The script also describes the use of a histogram to visualize MACD changes and a 9-day EMA as a signal line. It illustrates how MACD can signal trend reversals and emphasizes that while MACD is a powerful tool, its signals are probabilistic and should be used in conjunction with other analysis.
📊 RSI: Measuring Overbought and Oversold Conditions
The Relative Strength Index (RSI) is introduced as a leading momentum indicator developed by J. Welles Wilder. The script explains that RSI compares a stock's performance to itself over a 14-day period, oscillating between 0 and 100 to indicate overbought or oversold conditions. It demonstrates how RSI can be used to predict potential retracements in the market. However, the script also acknowledges the potential for 'stickiness,' where RSI may remain at extreme levels without immediate price retracement, highlighting the importance of using RSI as part of a broader analysis strategy.
Mindmap
Keywords
💡Indicators
💡Quantitative
💡Overlay Indicator
💡Underlay Indicator
💡Oscillators
💡Moving Average
💡Exponential Moving Average (EMA)
💡Momentum
💡Overbought and Oversold
💡Relative Strength Index (RSI)
💡Stickiness
Highlights
Indicators are the most popular tool among the trading community due to their quantitative nature and ease of plotting.
Indicators are calculations derived from price to understand market conditions such as overbought, oversold, or momentum.
There are two types of indicators: overlay indicators like Bollinger Bands and moving averages, and underlay indicators like RSI or MACD.
Oscillators like RSI and MACD have a range from 0 to 100 and indicate overbought or oversold areas for potential market retracements.
Moving averages provide a baseline to understand the general price trend and reduce the noise of fluctuating prices.
The concept of a moving average is analogous to calculating a cricketer's average runs over a series of matches.
Exponential Moving Average (EMA) gives more weight to recent price movements, making it more responsive to current market conditions.
EMA can be used to identify the strength and direction of a stock's momentum and to predict potential trend changes.
MACD, developed by Gerald Apple, is a reliable momentum indicator combining two EMAs to show momentum changes.
RSI, developed by J. Welles Wilder, is a leading indicator that measures the relative strength of a stock's trend.
RSI oscillates between 0 and 100, with 70 considered overbought and 30 oversold, indicating potential retracement points.
The RSI can sometimes be 'sticky,' failing to indicate retracement when a stock continues to move in one direction.
Understanding indicators like Bollinger Bands and ATR can provide further insights into market volatility and trends.
Key takeaways from the video include the importance of using indicators for quantitative analysis and trend identification in trading.
The video emphasizes the probabilistic nature of technical analysis and the importance of combining indicators for better trading decisions.
For a deeper understanding of indicators, the video suggests visiting the corresponding varsity post for more information.
Transcripts
[Music]
hi guys my name is pritik singh and in
this video we're going to learn about
indicators
[Music]
indicators are probably the most popular
tool amongst the trading community and
people like it for two reasons one is
that it's quantitative which means you
can actually see a number on your screen
and based off of that take a trading
decision and second it's very easy to
plot i think after the advent of the
internet
calculating these indicators is done by
the charting platform so you can focus
on analysis so i think it's ease of use
anyway an indicator basically is a
calculation that derives itself from
price so basically there will be some
hypothesis on the price itself and based
on that an indicator is drawn which
helps you understand if maybe the market
is overbought or oversold less in
momentum or more in momentum near its
average or away from its average so on
and so forth now visually when you look
at a price chart you will see two types
of indicators one indicator which is an
overlay indicator which is plotted right
on the price chart itself for example
the bollinger bands and the moving
average are plotted on the price itself
another type is the underlay indicator
so that is a separate pane right under
the price like an rsi or a macd these
are different indicators we learn in
this video and that is on a separate
pane itself and i'll show you what that
looks like on a chart too now whenever
you're looking at things like the rsi
and the macd they have a range they
start from 0 and n at 100 and they
oscillate from 0 to 100 and that's why
they're called oscillators as well
because they oscillate between two
minimum and maximum numbers 100 and 0.
also there is an overbought and oversold
area for all of these oscillators
usually so for example when price moves
up a lot and we reach an overbought area
it means that many people have bought
and momentum will likely die now and
it's become overbought and market is
likely to retrace a little bit and when
markets move down or very large sell-off
when markets fall it is said to be
oversold at a certain level on the
indicator meaning that there will be
some retracement now because it's been
oversold but anyway i think now it's
time to actually see an indicator in
action and we're going to start with the
moving average so let's start with the
moving average before we actually look
at a price chart let's understand moving
average through an analogy a moving
average remember is nothing but a
running average for a period of time
but like i said before we do stocks
let's talk about cricket let's imagine
there are two batsmen there is batsman a
and there is batsman b
now let's imagine both of them play five
matches each so i'll just draw
five circles to represent this
so now let's imagine what each of these
circles represent they represent a match
played by player a and a match played by
player b five matches each let's see
what number of runs they have so bassman
a does
76 runs 20 runs 65 runs 72 runs and 17
runs this brings us to an average of 50.
so
batsman is first five matches gives him
an average score of 50. batsman b on the
other side is at 96 98 99
87 and 120 his average on the other hand
is 100. so what we have over here is
sort of like a five match average so
i'll just write it here
five
match
average now i have a space over here
i'll tell you why i've done that
what if we have a sixth match
well since we're only doing five matches
instead of seeing the first five we will
drop the first
for both the matches and we'll only take
the second match till the sixth match
and we'll have a five match this time
the average for batsman a is 40 and
average for batsman b is 94. therefore
this is a five match
moving average
now of course these batsmen are not
going to stop right here and we have to
continuously calculate their five match
moving average and the word here is
moving the concept you have to
understand is that we are finding the
average for a period and dropping the
last number and adding the next number
and we keep moving that's why it's
called a moving average the same concept
is applied to stocks but you just take
the closing prices for every day and
decide the period it could be a five day
average a ten day average a 200 day
average and that keeps moving hence
giving us a moving average of the price
stock so let's see what this looks like
on a chart
and it's actually pretty simple i'll
first open a daily chart
let's say hindustan unilever and i'll go
to indicators i'll search for moving
average
and i'll be able to set
settings to say 50
and look at this source source means the
close which means the data that we're
plotting for this line chart is a single
data point on a daily basis and that's
the close of the day
and we will see here that we have this
moving average of hindustan unilever
you'll notice that the line is
continuous it is calculating the last 50
days as we add a new day it will drop
the first day here add the new day and
the average will keep moving ahead now
for a trader why is this important well
the first most obvious thing is that
it gives you a baseline or an average
all the noise of prices into just a
single line so if i zoom out you can see
that most of the time the price is
always around the average right if
you've studied statistics people talk
about the tendency of mean or the
tendency of how numbers tend to revolve
around the mean which basically means
that price tends to be near its long
term average and in this case it's
actually very near its average sometimes
it moves on one extreme then comes back
to the average moves on the other
extreme and then goes back to the
average so and so forth i can also
change
the
period from 50 to say 100
and this time i get a more smoother line
so as you increase the period the
smoother the line becomes because more
data points represent one point on the
moving average and it just becomes
smoother so what i'll do is i'll add
another moving average
and i'll give it a color of yellow
and
i'll give it a length of
200.
and you can now see the difference
between 100 and 200
that the 100 has a little more detail it
moves up a little bit more the 200 moves
a little less and is a lot more smoother
because it's a longer term moving
average so now that you've understood
moving averages let's talk about an
exponential moving average i'll keep it
simple basically when you're looking at
this batting example we talked about
the latest match has more relevance
than five matches ago so how this
batsman performed in the last match is
more relevant to predict the next
match's outcome versus what he did five
matches ago or if this was a longer term
average then i would say
the last match has more relevant than 50
matches ago
the same applies for stock as well
because stocks can move very quickly the
latest data points have more weightage
or more relevance than 50 days ago or
whatever your period of moving average
calculation so what we can actually do
is we can give more weightage
to the recent price movement
[Music]
so when you give weightage to recent
data
that kind of moving average is called an
exponential
moving average let me show this to you
on a chart so the same chart we just saw
we now have hindustan unilever we've
already drawn the 100-day moving average
i will simply add an ema
of 100
in orange and you'll notice both of
these moving averages are 100 but if you
look a little closer let me zoom in
look at this fall
we can see markets went up the moving
averages were sort of still sideways
then when markets fell
the white line or the normal simple
moving average which does not have any
weights continued to move up because it
is averaging the last data
but the orange line actually moved down
quicker can you see that because it was
reacting to the latest data more
therefore a lot of traders use
exponential moving average because it
gives you best of both worlds
it gives you a running moving average
you get a great idea but it also reacts
to the latest price data faster so the
most common way of using a moving
average is to know whether the stock is
in an uptrend or a downtrend i know you
can visually see it on a chart but to
have a quantified version of it which is
the advantage of an indicator is a
moving average so if the price is
generally above a moving average it is
generally thought that it is a bullish
market if you're under the moving
average it is thought that we're
generally in a bearish market now two
points to note here you want the moving
average to be a little long you don't
want to be doing this with a five period
moving average or the trend will keep
changing for you so try a 100 moving
average or a 50 or a 200 moving average
and also use this on something like a
daily chart and above whether the market
is in an uptrend or whether the market
is in a downtrend the next indicator is
the moving average convergence
divergence now actually this indicator
is really old it was started in the late
70s by gerald apple it's considered to
be one of the most reliable momentum
indicators by the trading community so
let's understand how it works two
exponential moving averages that's the
12-day ema and the 26-day ema
are subtracted to get a value now this
value if if it's negative you'll get an
macd line that's below zero if that
value is positive you'll get an macd
line that's above zero now people use an
macd line or you can use a histogram
which is slightly easier to see as the
macd moves above zero and below zero now
apart from the macd line that we just
talked about there is also a nine ema
line that will run throughout the chart
you can see that right here now since
this is a momentum indicator it's giving
you indication of momentum and direction
so you can see here
that the
trend moved from down to up now you can
see here that hindustan unilever has
been falling continuously
and the macd histogram this is actually
below zero in negative territory
right around this area
the histogram turns above 100 and starts
giving you four five six seven
numbers and that's when the trend
has turned upwards
and the market has also moved upwards um
you can see right after that the reverse
happens when this bar falls down we can
see that the histogram is now below zero
and the momentum is now downwards and
surely enough the market actually falls
from there so on and so forth so you can
use this as a way to understand
direction as well as strength of
momentum when the stock is in a trend
another way to use the macd indicator is
to just look at the two lines that you
see here and if they cross like this
under that means the trend is going to
move downwards but if it crosses like
this towards an uptrend it shows that
the market is likely to move upwards so
simple example is right here we can see
that the white line was slanting
downwards and the yellow then converges
downwards as well and after that we can
see that the market broke down and we
fell from there
and then the opposite happens
both lines converge upwards and we can
see that there's a breakout and the
market moves upwards now just like
everything in technical analysis every
time there's a convergence divergence or
every time the histogram moves above
zero or or turns below zero it doesn't
mean that the trend will change all of
these are probabilities and it is
completely probabilistic in nature that
the market is likely to
so i hope that makes sense and that is
what the macd indicator is
the next indicator we're going to talk
about is the rsi or the relative
strength index now this word can be a
little misleading it doesn't compare to
stocks rather it compares the stock
itself and it tells us relative to
itself whether the trend is strong or
not it was developed by an engineer
called j
wells wilder the rsi is a leading
indicator so it's not a lagging
indicator it's considered to be a
leading indicator momentum in nature and
that's what it measures so let's see how
this works it's very simple if you want
to understand the calculation behind the
rsi i'd suggest you read the varsity
post which explains this really well
i'll give you an overview and focus more
on the price action on the chart so the
rsi will basically count each game day
so as you have bullish days into points
and will also count the loss days and
convert them to points and based on
these numbers it'll actually draw an
oscillator it'll draw a line which
oscillates between zero and hundred now
the reason why it oscillates like i said
before
it shows overbought and oversold
zones the usual period calculation for
rsi or the number of days that it
calculates to actually draw
the rsi line is 14 and the 14 period rsi
is actually standard throughout the
industry so let's see what this looks
like on a chart so i'm going to continue
with our hindustan unilever example
since we've been leading with that for
the last few indicators
so you'll notice we have a line over
here that's the rsi line it's
oscillating between a maximum of 100
and a minimum of zero and we also have a
range over here of 70 to 30. so
basically these numbers are standard in
nature the 14 period rsi now we've also
marked 70 and 30 as upper and lower
limits or upper and lower bands
so 70 is considered to be overbought and
anything below 30 is considered to be
oversold so when markets touch the
oversold area that's around 30 we expect
a bounce back up and when we see markets
going up to 70 we expect it to fall or
retrace from that point so let's see an
example
i can see that
hindustan unilever right here was
falling
this red bar actually dipped below 30
then it was sideways for a period of
time before it bounced back up
[Music]
here's another example the market was
falling
and we can see this rsi over here
this bar right here this red bar went
below 30
and then after that the market actually
bounced back up now there's one
disadvantage of an rsi
and i will talk about that as i show you
the opposite example that's the
overbought example so
that's right here this is a good example
so we can see that hindustan unilever
was moving up
and right about here this green bar
is when the market went above 70 that
means it it's become overbought
and the market has actually fallen after
that
and we've seen the market to fall
now the disadvantage i was talking about
is called stickiness so sometimes the
market can go up and continue to move up
and the rsi just sticks on the top of
100 and becomes a flat line until it
falls which means that sometimes this
pattern does fail sometimes this
indicator does fail and one example of
that is here the market gapped up it
went way above 80 and it just stuck to
80 75 range for a really long period of
time before falling actually almost a
month and this is what i meant by just
sticking on the top and staying there
for a long period of time and not
actually retracing uh this is true for
both bullish and bearish markets so i
have another example for you and over
here it's reliance we can see that the
market has been falling and you have
this huge gap down at this point the
bears are in control and the market has
really been sold into for the last few
days and so much so especially on this
day that's 24th august
now the rsi at this point curiously
falls below the 30 mark actually it's
around 22 which means we're below and
now it's oversold oversold basically
means at some point there will be some
retracement because there's been too
much selling at this point and we can
see that the market was actually
sideways after that for some time
before moving up
so that's an example of an oversold
example using rsi so i hope you learned
a lot we talked about different kinds of
indicators there are actually many many
indicators to learn from if you don't
want to stop your momentum and learn a
few more indicators i suggest you go to
the corresponding varsity post see the
bollinger bands and see the atr
indicator and you can continue our
discussion right there and learn a
little bit more about these volatility
bands key takeaways from this video are
[Music]
you
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