Technical analysis is gaining steam, but there are misconceptions about the best indicators in different market environments. Brush up on trend-following.
I’m a longtime disciple of technical analysis and use it almost exclusively in my trading, which is why I am so glad it’s becoming a more mainstream tool for investors. But despite its growing popularity, there are still some misconceptions about which types of indicators work best in different market environments.
Most technical indicators fall into one of two categories: trend-following or range-based.
Trend-following indicators, as the name indicates, are designed to take advantage of trends in the market or an individual stock. Examples include moving averages, the average directional index (ADX), and on-balance volume (OBV).
Range-based indicators are mostly designed to show overbought and oversold conditions in a price range and include Bollinger Bands, the Commodity Channel Index (CCI), the Relative Strength Index (RSI), and stochastics. Some indicators, like the moving average convergence divergence (MACD), can be used to generate either a trend-following or a range-based trade signal depending on the time periods used in its calculation.
Let’s take a look at how both types of indicators can be effective in different sample market conditions and time frames using the charting tools on the thinkorswim® platform from TD Ameritrade. Take a look at the following figures and their descriptions.
Can these indicators sometimes work in combination? You bet. Both trend-following and range-based indicators can work on shorter time frames as well, such as those used for day trading.
There are a wide variety of trend-following and range-based indicators available on the thinkorswim platform. Understanding how they work, and more importantly, when to use them, can help you fine-tune your trading and potentially improve your winning percentage.
The water's fine. Ready to take a swim? Serious tools and a deep bench at thinkorswim® help you stay on the top of the market.