Moving averages are used to smooth out the volatility that occurs on a price chart by calculating the average price for a number of time periods. The longer the time periods are used, the smoother the line becomes. Signals indicating trends are typically generated by the crossing over of one moving average over another. The 20 day MA is commonly used by traders for this purpose and the second MA is more a matter of preference. It could be a 50 day MA, 100 day or another one. The smaller they are, the earlier and more frequently trade signals will be generated and this also produces more false signals, or whipsaws. The larger MAs produce fewer signals and whipsaws but this also increases the lag time involved when generating them. When the prices move sideways and become range bound, MAs aren't practical to be using because the price fluctuations become fast and short-term.
Moving Average Convergence Divergence (MACD)
The MACD is a popular tool that exhibits the best of two worlds. It's a trend following indicator and also an oscillator. The momentum of price movements are plotted using the difference between two exponential moving averages (26 day EMA - 12 day EMA) overlaid on a centerline. Another MA (9 day) is added that is the average of the existing MA that confirms the direction of the momentum. The distance between the two MA lines indicates the strength of a trend. The greater the distance, the stronger the trend. Signals are generated when crossovers occur at the extreme upper and lower areas of the chart and when the MAs cross the centerline. The MACD also indicates price strength or weakness when the two averages begin converging or diverging in relation to the price movements on the price chart. As mentioned before, this could be a signal that a reversal might soon be imminent.
Relative Strength Index (RSI)
The RSI is a momentum oriented banded oscillator that indicates overbought or oversold conditions on a price chart. The range is set between zero and 100 with the overbought and oversold margins set at 70 and 30 respectively. It uses a 14 day MA that can be adjusted for longer or shorter term readings. A signal is generated when the MA crosses into the two extreme regions. This indicates that there is some price weakness that can become a price reversal.
Bollinger Bands are a volatility oriented indicator that utilizes a 20 day exponential MA that is flanked by two bands that form a channel. The upper band is a positive two standard deviations from the MA line and the lower channel is a negative two standard deviations below the 20 day MA. Signals are generated using the upper and lower bands. The price touching or breaking through one of the bands could be a signal that conditions are good to be buying or selling in anticipation of a return to the MA line.
On Balance Volume (OBV)
The OBV is a volume oriented indicator that measures the momentum of price movements in relation to the trading period volume. Its calculations are quite straight forward. It's an adjusted accumulation of the period’s volume compared to the price chart. The upward movement of one day’s price would be a positive value and the downward movement of the price would be negative. These are just added together each day to produce a chart.
Signals are based on the trend of the OBV in relation to the movement of prices on the price chart. When there is a positive divergence between the OBV and the price movements, it is considered an increase in selling pressure, as prices are rising and the trading volume is falling from a lack of interest. This will mean an eventual drop in the prices. The opposite holds true for the decreasing buying pressure during a negative divergence. These signals are usually used to confirm the strength of trends. When they are moving in the same way, the trend is strong and when they aren't, the trend is weak and could change.
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