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Understanding Stock Options Trading
and Technical Analysis Basics |
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"I've always been confused about options trading...
at least now I have a better understanding about it!"
Ben Masters
VIC, Australia
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> Technical Guide
> Technical indicators |
Technical Indicators
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As the name suggests, Technical Indicators
are used to indicate trends and possible turning
points in stock prices. These are the tools
used by Technical Analysts to predict cycles,
and to predict when is the best time to buy
or sell a stock or option.
Technical Indicators are calculated based
on a particular stock or derivative's price
pattern. Data such as opening price,
closing price, highs, lows,
as well as the volume, are used to
create the many technical indicators out there.
The indicators generally take the stock's
price data from the last few periods (for
example the last 30 days). They use that data
to create a trend or chart to indicate what
has been happening to the stock, and hopefully
predict what may happen in the future.
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Technical
Indicators are used to indicate
trends and predict future
stock price movement. They are based
on the stock's price data,
usually from recent periods.
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There are two main types of indicators: Leading
Indicators and Lagging Indicators.
Lagging Indicators are indicators which
follow the stock's price pattern, hence the name
"Lagging" Indicators. Since they are based
on past data, they are good in showing whether a
trend is developing, or whether at stock is in a
trading range (ie. trading sideways). For example,
lagging indicators can show that a stock has developed
a very strong downtrend, and is therefore likely
to continue falling.
On the other hand, Lagging Indicators are
not good when predicting future rallies or
pullbacks. They can show what trends have
developed until the current point, but are
not able to predict the next few days' movement.
Examples of Lagging Indicators include trending
indicators such as the Moving Average, MACD
and ADX indicators, which we will be covering
later on.
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Lagging
Indicators are good in showing
the trends that have developed, but
are not good in predicting future
price movement.
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On
the other hand, Leading Indicators,
as the name implies, are better at predicting
possible future price rallies and crashes.
Most Leading Indicators are momentum indicators,
gauging the momentum of a stock price's movements.
Imagine a football we are throwing up in the air.
Common sense indicates that the football cannot
keep going higher forever. We might not know how
high it will go, but we do know that once its upward
speed starts to slow down, it will soon stop going
up and start falling down again. That is the basis
of momentum indicators.
Leading Indicators are good at telling us whether
a stock's price has gone too high up or too far
down, and whether there is a slowdown in price movement.
If the stock's price has gone too high up, we say
that the stock is now overbought. If the
price has gone too far down, we say it is oversold.
In either case, the leading indicators will show
that the stock will not remain overbought or oversold
for long. A pullback is imminent.
Examples of Leading Indicators include the
RSI which we will cover later, as well as
other momentum indicators.
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Leading
Indicators include momentum indicators
that can predict if a stock is
overbought or oversold, and thus
can predict pullbacks in the near
future.
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Both Leading and Lagging Indicators are equally
important. We need to know both the trends
that are developing as well as possible slowdowns
and price pullbacks.
In fact, investors are advised not to base
their decisions on just one indicator. After
all, no indicator is perfect. All indicators
can produce false signals from time to time.
Therefore, it is recommended that investors
take 2 or 3 indicators they are comfortable
with, and base their decisions on them (ie.
only buy when all 3 indicators tell you to
buy).
There are hundreds of indicators in use at
the moment. In fact, any high-profile stock
market guru will most likely have developed
his own indicator to predict the market. However,
in this guide we will only cover 5 indicators,
which are based on different data and serve
different functions.
In doing so we hope to expose you to the various
types of indicators out there, and enable
you to choose which type of indicator you
are more comfortable with.
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| All stock options trading
and technical analysis information on this website is for educational
purposes only. While it is believed to be accurate, it should not be considered
solely reliable for use in making actual investment decisions.
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© 2004-2007 Option Trading Guide. All rights reserved. |
