Lesson 11: Understanding the principle of operation of technical indicators

Technical indicators are the second of the three fundamental knowledge groups that I mentioned in previous articles. There are thousands of technical indicators and people still create different technical indicators every day. You can also create your own technical indicators. Basically, it is an indicator that is calculated based on price and volume movements.

Two groups of indicators

Since there are thousands of technical indicators, beginners are often overwhelmed and have a feeling of complexity because even its name is hard to remember. But if you know that it actually only has two groups of indicators and almost all the indicators in the same group work the same, so you just need to study and master 1-2 indicators in each group is enough. 

The two groups of indicators that are mentioned include the moving average group and the trend strength indicator group. For the sake of simplicity, when you use the technical charting that most financial sites in Vietnam provide, you just have to remember that whatever indicator you add it attaches to the window. price chart, it is a group of moving average indicators. Examples of this group include MA, SMA, EMA, Bollinger Band, etc.

As for the indicators that belong to the group that show trend strength, when you add it, it will have a separate window that is not the same price window. Examples of this group include the RSI, CCI, Momentum, Stochastic Oscillator and Williams %R… Some very, very bipartisan indicators, like the MACD, are in a separate window but they can be considered as averages. motion.

The general perception is that the moving averages are usually slow and provide confirmation of price action that has occurred, while the indicators that show trend strength are often leading and can be used to warn of future price action. next price change. This, however, is not the case in my opinion. Because if it can lead and predict, it's easy. All technical indicators are slow because they reflect the past. But it helps us to make judgments if combined with price and volume analysis to identify market sentiment. And of course you should put technical analysis in a big context of fundamentals too.

Important Principles

An important rule of technical analysis that you need to remember is that until everything is confirmed, all actions must be based on the present continuum. For example, if you see a reversal pattern or a technical indicator that is showing a potential reversal and you are waiting for it to confirm, don't rush to act in the meantime, but act like it's ongoing. until it confirmed. And when it is confirmed, your course of action should be to immediately let go of the old image, without trying to force your thoughts or hold your thoughts to the old. Most important changes, especially trends, often have a retest phenomenon, so you need to be mentally prepared for this.

How to use

Back to the issue of technical indicators, how to use them is important. In addition to you should only choose 1-2 indicators for each group you really trust or are simply easy to use, you should develop your own method of reading technical indicators, depending on the group of indicators.

With a group of moving averages, you should treat them like dynamic support and resistance lines. This method is usually best used in a trending market. And if it's an oscillating market, then using it as an up/down crossover – ie the price line crosses the moving average, or the short moving average cuts the long average… is often used. 

With the group of indicators showing trend strength, there are three methods of using it. This group of indicators is usually characterized by having 3 upper, lower and average limits or at least it revolves around a center line. The easiest way to read it is if it's pointing up or down, indicating whether the current price trend is stronger or weaker. When it enters the upper limit, it is called overbought – overbought, and when it enters the lower limit, it is called oversold – oversold. The fact that it is overbought or oversold does not necessarily mean that its price will fall or rise again immediately, but it does mean that you should closely monitor price and volume movements to consider. This usage is often used by people who are just starting to use technical analysis.

The second reading method is to use the knowledge of support and resistance lines applied to the indicator. That is, you analyze the index just like you analyze the price. If it meets a previous high, it is also trending down, and when it reaches the previous low, it could signal a reversal. This usage is often used for sudden spikes and drops in price, roughly called bottom-fishing or peaking in a fast-moving market.

The third reading method is to use the knowledge of psychological behavior to explain. Since the indicators show the strength of the current trend, if the price increases but the strength decreases, or the price decreases but the strength increases, those are all signs of impending reversals. Of course, that's just a warning and you need to look at price and volume as well. Note that this reading method is generally best used for observing price movements over a period of time, in other words suitable for trend trading. In the technique it is called divergence analysis between price and index.

Understanding the basic principles outlined above and practicing observing the past will help you use technical indicators more confidently. And again using the word basic in this or other articles doesn't mean it's simple, it's actually what people call advanced technical analysis.