This week's article will be an overview of what is a broad subject; technical indicators. Subsequent articles will cover some of the more popular indicators in detail, but we will cover the basics to start.

Many traders use technical indicators to some degree to help them in their market analysis and trade management. Technical indicators are like a weather forecaster. They don't tell you what is certain to happen, but are a guide to prepare you what may “likely” happen.

Technical indicators are formulated by entering information such as price and volume into a mathematical formula. This formula produces a data point. Data points are collected over a period of time. Technical indicators can be found above or below charts. Others are plotted on top of the prices on the chart. A few popular technical indicators are shown on the chart below:

SPX Chart showing 50-Day and 200-day Moving Average, MACD, RSI and Williams %R

Traders who use indicators look for them to help predict where prices may be heading. Some indicators show whether or not the underlying is “overbought” or “oversold”. Being overbought or oversold does not always mean that the underlying will continue to stay there, or reverse.

**Overbought:**This is a technical condition that happens when there has been a lot of buying, and the price of the underlying is considered to be too high; making it susceptible to a decline.**Oversold:**This technical condition occurs when there has been an abundance of selling, hence the price is viewed as being too low. This brings anticipation that a rally in price is expected.

In general terms, many traders use technical indicators for two things:

- To generate buy and sell signals
- To confirm price movement

**Leading Indicators** precede price movement. These are often used as a general buy and sell signals. Most leading indicators represent some form of price momentum over a given period of time. Leading indicators are affected more by recent price changes, and tend to generate more signals which allow more opportunities to trade, than lagging indicators. Some of the more common leading indicators are Stochastics, Williams %R, and the Relative Strength Index.

Leading indicators at times can allow a trader to enter a trade early; possibly making greater profit. However, they are not “always” right. When they are wrong, you can lose more money relying on them, because you are entering and exiting trades more quickly.

Sometimes, what you think will happen doesn't always happen. That is where another type of indicator, the lagging indicator, may help.

**Lagging Indicators** are a confirmation tool because it follows the underlying's price movement. It happens “after the fact. After prices have been trending for a period of time, the lagging indicator may produce a signal that the trend may be changing. It solidifies at a certain point, and then the confirmation is more apparent that the trend is, in fact, changing. Two of the more common lagging indicators are: MACD and Moving Averages.

There are so many technical indicators out there for traders to use today, entire books have been written on the subject. Trading platforms have dozens and dozens of choices for traders to use in their trading, and some traders write their own scripts for technical indicators. However, many traders feel that the “King and Queen” of indicators is twofold and very simple…price and volume. A non-technical trader may see technical indicators only as a mathematical formula with data points plotted into them and may choose not to use them feeling that the formulas can be manipulated. Instead, they may choose to just use price and volume which tells the true story… created by real investors buying and selling the underlying.

Technical indicators are a terrific tool for traders to use as an adjunct to price and volume and are most often used as a guideline – not a rule – in trading.

Future articles will cover some of the popular technical indicators in a bit more detail.

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]]>The origin of moving averages can be traced back to 18th Century Japan, and are now used by the majority of traders in some form or another. Those who have studied the early use of moving averages have the understanding that simple moving averages (SMA) were used long before exponential moving averages (EMA). The reason is believed to be because EMAs are built upon the SMA framework, and the SMA was more easily understood during the early use of moving averages. This week I will cover the basic differences between these two types of moving averages.

A simple moving average is built by calculating the average of a certain period of time. For instance it could be minutes, days, weeks, months, or years.

Some traders prefer to use simple moving averages for tracking market price action because they are easy to understand and calculate. In the early days of trading before the sophisticated technology available today, traders had to rely primarily on market price action as their only means of technical analysis. Many had to calculate market prices manually, and plotted those prices to determine a trend.

To calculate a simple moving average, let's use a 20-day moving average as an example. Simply add the closing prices of the last 20 days, and divide by 20.

While this formula is a simple one, it is worth noting that the SMA formula is not only based on daily closing prices, but it is a mean of prices – a “subset”. It is called a “moving average” because the group of closing prices used in the calculation relate to the points on the chart. This means the older days are dropped from the calculation of the SMA in favor of new closing price days. Therefore, a new calculation is always needed to correspond to the time frame of the average being used. So, in the 20-day example, this is recalculated by adding the new day and dropping the previous 20th day.

The exponential moving average has been increasing in popularity by many traders over recent years. The EMA focuses on the most recent prices, rather than a long series of data points. With technology available today, the EMA is calculated automatically on most charting services. The EMA gives weight to more recent prices, and it gives more emphasis on closing prices which are closer to the present time. For those interested, however, below is the formula for calculating the EMA, according to Investopedia.com.

Formula to Calculate EMA Courtesy of Investopedia.com

To illustrate the differences between these two moving averages, both are plotted on the SPX chart below:

SPX 6 Month Chart with EMA and SMA

The above chart indicates the 50-day EMA (black) and SMA (blue). Note that the EMA responds more quickly to changing prices than the SMA. You will notice how the EMA has a higher value than the SMA when prices are rising, and also falls more quickly than the SMA when prices are declining. This responsiveness of the EMA is one reason many traders prefer to use the EMA over the SMA.

Whichever moving average you may choose to use, both can be customized to a trader's preference. Some of the most common time periods used in moving averages are 15, 20, 30, 50, 100, and 200 days. The shorter the time span used, the more sensitive the average will be to changes in the price of the underlying. The longer the time frame, the less sensitive the moving average will be. There is no time frame that is perfect for every trader and every strategy.

Traders using moving averages usually experiment with various time periods in order to find one, or multiple, that suits their trade strategy.

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