10. Technical indicators

Summary

In 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

00:00

📈 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.

05:02

🏏 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.

10:02

📊 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.

15:03

🌐 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.

Keywords

💡Indicators

Indicators in the context of the video refer to tools used by traders to analyze market trends and make informed decisions. They are derived from price data and can help in determining whether the market is overbought or oversold, among other insights. The script explains that indicators are quantitative and easy to plot, making them popular among traders.

💡Quantitative

Quantitative in this video script means that the indicators provide numerical values that can be visually represented on a trading chart. This allows traders to make decisions based on specific numbers, as seen with indicators that show market conditions in a numerical form.

💡Overlay Indicator

An overlay indicator is a type of indicator that is plotted directly on the price chart itself, such as Bollinger Bands or Moving Averages. The script mentions that these indicators provide insights into market trends by visually overlaying the price data, giving traders a direct comparison between price movements and the indicator's values.

💡Underlay Indicator

Underlay indicators, as explained in the script, are plotted in a separate pane under the price chart, unlike overlay indicators. Examples include the RSI or MACD, which are used to analyze the momentum and volatility of a security's price movements independently from the price chart.

💡Oscillators

Oscillators are a type of indicator that fluctuate between a minimum and maximum value, typically between 0 and 100. They are used to identify overbought and oversold conditions in the market. The script describes how RSI and MACD are examples of oscillators, which help traders anticipate potential trend reversals.

💡Moving Average

A moving average is a widely used indicator that smooths out price data by creating a constantly updated average price over a specified number of periods. The script uses an analogy of cricket scores to explain how a moving average is calculated and how it can provide a baseline to understand the general trend of a stock's price.

💡Exponential Moving Average (EMA)

The Exponential Moving Average gives more weight to recent data points, making it more responsive to recent price changes than a simple moving average. The script explains that EMA is useful for traders who want to react to the latest market trends quickly, as it places more emphasis on current price movements.

💡Momentum

Momentum in trading refers to the rate of change of price. Indicators like the MACD are used to measure momentum, helping traders to understand the strength and direction of a trend. The script illustrates how the MACD can indicate when a trend is gaining or losing strength based on its position relative to zero.

💡Overbought and Oversold

Overbought and oversold are terms used to describe market conditions where asset prices have risen or fallen sharply to a level that may be unsustainable. The script explains that oscillators like the RSI can indicate when a security is overbought (above 70) or oversold (below 30), potentially signaling a reversal in the trend.

💡Relative Strength Index (RSI)

The RSI is a momentum oscillator that measures the speed and change of price movements on a scale of 0 to 100. It is used to identify overbought or oversold conditions of a stock. The script describes the RSI as a leading indicator, which means it may predict future price movements based on current trends.

💡Stickiness

In the context of the RSI, stickiness refers to a situation where the RSI indicator remains at extreme values (overbought or oversold) for an extended period without triggering a price reversal. The script provides examples where the RSI remained at high levels even as the stock continued to rise, indicating a potential failure of the oversold signal.

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