Indicator Basics: How To Use Technical Indicators
Searching For The Holy Grail
Most technical indicators highlight a particular aspect of price or volume behavior. Newcomers often attach mystical significance to their favorite indicators, but none are infallible. Technical indicators are great for stock-screening, but, if possible, base final decisions on the price chart.
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Keep It Simple
Select a small number of indicators (2 or 3) and use them to confirm signals from each other.
Know Your Indicators
Study their behavior until you know them well. Indicators are like a carpenter's tools: skilled use can produce excellent results, unskilled use may lead to injury.
Use Contrasting Indicators
Select indicators that complement each other and are not based on the same data. For example, three indicators based on closing price will tend to confirm each other; while indicators based respectively on closing price, volume and trading range will often conflict and are therefore more reliable when they do confirm each other.
Active or Reactive?
Many investors follow active strategies but end up being reactive, rotating in and out of stocks at the wrong time.
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Trending & Ranging Markets
No one indicator is suited to all market conditions. Trend indicators lose money during a ranging market, as fluctuations in a narrow price range whipsaw traders in and out of positions. In a trending market, momentum oscillators give exit signals too early and should only be used to confirm trend indicators.
Use a trend indicator in a longer time frame than the cycle being traded (e.g. if trading the secondary cycle, use a 100-day exponential moving average to indicate the direction of the primary trend).
The Trend Is Your Friend
Only trade in the direction of the trend as signaled by the moving average.