Technical Indicators for a Second Confirmation
There are hundreds of technical indicators, many reliables, others not. There are for the taste of each trader and his trading style. In my case, after having tried many of them during my years of trading, I decide to manage few technical indicators just for "the second confirmation", which means as a complement to use in conjunction with the main one, the Price Action Analysis, only to reinforce any bull or bear signal.
Usually, you only need two, a maximum of three, indicators for each timeframe. It's enough. Remember, there are just indicators, not a strategy. There's no infallible or magic indicator: all of them give false signals. Select and use your favorites indicators in multiple timeframes, making the strategic decision on the major and the tactical choices on the minor timeframe.
Usually, you only need two, a maximum of three, indicators for each timeframe. It's enough. Remember, there are just indicators, not a strategy. There's no infallible or magic indicator: all of them give false signals. Select and use your favorites indicators in multiple timeframes, making the strategic decision on the major and the tactical choices on the minor timeframe.
The most popular: MACD and RSI
The MACD (Moving Average Convergence/Divergence) combines trend with momentum (or acceleration) of the price, and its signals are simple, we know: bull and bear crossovers, line plot above zero means trend up, the plot below zero means trend down, a rising histogram means buyers in control increasing momentum, a falling histogram means sellers in control increasing momentum. And we get a trade signal (that needs confirmation) only when the crossover is bullish AND the histogram is rising. Or a bearish crossover with the histogram falling. Avoid the two other combinations.
A trend-trader can get good signals from the MACD. A bullish one, first need to verify the uptrend, then check if MACD line is below zero and wait for an uptick in the histogram (tells momentum is shifting) for buying that pullback due to the local weakness of the trend is reversing.
My personal contribution: take care of the divergence of MACD-histogram with price in daily charts, because they had frequent errors if it is not used correctly. For this reason, the recognized trader Alexander Elder recommends using the EMA13 line as a confirmatory signal, verifying that its slope points in the direction of the divergence, bull or bear. In my trading, sometimes I add a second confirmation with the same MACD but in the weekly chart: verify if a MACD crossover matched with the divergence of the daily chart. Verify it.
The RSI (Relative Strength Index) is also an oscillator but it gives different information than the MACD. It qualifies the situation of the stock as overbought or oversold according to the value of the indicator on a scale of 1-100. Its crossover at levels 30 and 70 are used by traders as a probable reversal.
My personal contribution: take care of the divergence of MACD-histogram with price in daily charts, because they had frequent errors if it is not used correctly. For this reason, the recognized trader Alexander Elder recommends using the EMA13 line as a confirmatory signal, verifying that its slope points in the direction of the divergence, bull or bear. In my trading, sometimes I add a second confirmation with the same MACD but in the weekly chart: verify if a MACD crossover matched with the divergence of the daily chart. Verify it.
The RSI (Relative Strength Index) is also an oscillator but it gives different information than the MACD. It qualifies the situation of the stock as overbought or oversold according to the value of the indicator on a scale of 1-100. Its crossover at levels 30 and 70 are used by traders as a probable reversal.
I use this indicator only as a reference of how the buyer/seller sentiment is coming from the traders. I never take its signal as an indication of action (with any indicator it should be done!), because the main weakness of the RSI is that it can be a very long time as overbought while the stock continue trending, due to greedy traders still in their positions trailing their stop-loss. RSI oversold it's usually give a more clean information: time it stay below 30 is more punctual, due to traders' natural fear.
Previously I should refer to two other popular indicators, which are quite similar but give different readings. Both plotlines as an envelope around the price, based on stock volatility. The Keltner Channels use a smooth exponential moving average as mid-line and the Average True Range as offset, while the Bohlinger Bands (BB) uses a simple moving average and offset with the standard deviation, which varies proportionally with the volatility. Both are useful as trend-following indicators, and its a good idea to use them with a momentum oscillator as a Stochastic or RSI.
- The upper and lower bands of the Bohlinger represent overbought and oversold levels. The BB works best in ranging than trending behavior of a stock. Take note that touch a band isn't necessarily a sign of reversal, but probably a low-risk entry point.
Less popular than those described above, the OBV is a trend indicator that measures the pressures of buying and selling, adding/subtracting volume on up/down days. Is simply a running total of up and down the volume: when the security closes higher than the previous close, all of the day's volume is considered up-volume, and when close lower than the previous day, all of the day's volume is considered down-volume.
As it uses volume in its calculations, and volume, in theory, precedes price, the OBV has truly good advantages versus others:
- A rising OBV reflects positive volume that can lead to higher prices.
- As rising volume confirms an up or downtrend, if price movement precedes OBV, then it is considered a "non-confirm" movement.
- So, OBV breakouts normally precede price breakouts.
- An OBV ranging is an undecided trend: better hold until the trend changes.
- OBV is also useful for anticipating trend reversals, using its bullish/bearish divergences with a price.
- Be careful when volume spikes: it usually throws off the indicator at that point.
And a tip: use its best feature, its accurate bullish or bearish divergences with the price. There are more powerful when happening in wide (much better than tight) swings of price AND the RSI signal is at (or inside) the overbought /oversold level. Again: verify it!
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Is necessary to read the MACD with a confirmatory study as EMA13 (black line). This avoids false divergence signals as happen in the daily chart of pharmaceutical Novavax NVAX during July 2018. |
TTM Squeeze: a mix between Bohlinger and Keltner Bands
Previously I should refer to two other popular indicators, which are quite similar but give different readings. Both plotlines as an envelope around the price, based on stock volatility. The Keltner Channels use a smooth exponential moving average as mid-line and the Average True Range as offset, while the Bohlinger Bands (BB) uses a simple moving average and offset with the standard deviation, which varies proportionally with the volatility. Both are useful as trend-following indicators, and its a good idea to use them with a momentum oscillator as a Stochastic or RSI.
- The upper and lower bands of the Bohlinger represent overbought and oversold levels. The BB works best in ranging than trending behavior of a stock. Take note that touch a band isn't necessarily a sign of reversal, but probably a low-risk entry point.
- Keltner had different readings depending on stock behavior: if it's trending, a close above the upper is a bullish signal, while below the band is considered a bearish one. If it's ranging, envelope lines can be interpreted as overbought and oversold levels.
An indicator relates to both: John Carter's TTM Squeeze (TTMS). The idea is very logical: when volatility increases, the Bohlinger Bands are widening and enveloping the Keltner Channel, while when the market is consolidating (period of indecision) the Bohlinger is inside the Keltner and the market is squeezing, preparing for a breakout to come. A simple but great idea!
An indicator relates to both: John Carter's TTM Squeeze (TTMS). The idea is very logical: when volatility increases, the Bohlinger Bands are widening and enveloping the Keltner Channel, while when the market is consolidating (period of indecision) the Bohlinger is inside the Keltner and the market is squeezing, preparing for a breakout to come. A simple but great idea!
Carter designed the use of dots across the zero line: red dots indicate that squeeze is on, so a consolidation breakout is coming. Green dots represent squeeze off, so the market is trending. The trend momentum oscillator histogram is shown by colors: in my configuration, I use green for trend up and grey when it is decreasing, and red when the trend is down and grey when it's decreasing.
When the indicator is on (green) and the momentum oscillator is also green, it is considered a buy signal for a trend-trader. When the indicator is on (green) and the histogram is red, it is considered a sell signal. Both signals are supposed to be correct until two grey bars in a row appear. Try this interesting indicator in your favorite trading platform.
When the indicator is on (green) and the momentum oscillator is also green, it is considered a buy signal for a trend-trader. When the indicator is on (green) and the histogram is red, it is considered a sell signal. Both signals are supposed to be correct until two grey bars in a row appear. Try this interesting indicator in your favorite trading platform.
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The daily CREE chart above is showing some TTMS indicator features. The Average Directional Index ADX works fine with it, reinforcing trending or ranging signals. |
On Balance Volume (OBV), a different one
Less popular than those described above, the OBV is a trend indicator that measures the pressures of buying and selling, adding/subtracting volume on up/down days. Is simply a running total of up and down the volume: when the security closes higher than the previous close, all of the day's volume is considered up-volume, and when close lower than the previous day, all of the day's volume is considered down-volume.
As it uses volume in its calculations, and volume, in theory, precedes price, the OBV has truly good advantages versus others:
- A rising OBV reflects positive volume that can lead to higher prices.
- As rising volume confirms an up or downtrend, if price movement precedes OBV, then it is considered a "non-confirm" movement.
- So, OBV breakouts normally precede price breakouts.
- An OBV ranging is an undecided trend: better hold until the trend changes.
- OBV is also useful for anticipating trend reversals, using its bullish/bearish divergences with a price.
- Be careful when volume spikes: it usually throws off the indicator at that point.
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OBV divergences are infrequency but give powerful signals. Only use as a complement of your price action analysis. This ADP 2018 daily chart show three OBV features. |