Trading in Futures and Options: Understand the Risk
How to Use Others’ Choices for Your Stock Investment Decisions
ETFs, Mutual Funds, and the Vanguard Group

Using Chart Indicators to Make Investing Decisions

Technical investment traders go to great lengths to remove emotion and impulsiveness from decision-making. The chief tool for squelching emotion is the indicator, a calculation that you put on a chart to identify chart events, chiefly whether the price is trending, the degree of trendedness, and whether a trend turning point is being reached.

The purpose of indicators is to clarify and enhance your perception of the price move. They come in two varieties:

  • Judgment-based indicators: This group includes visual pattern-recognition methods such as bar, line, and pattern analysis, as well as candlesticks.

  • Math-based indicators: This group includes moving averages, regression, momentum, and other types of calculations.

Keep in mind that just because math-based indicators are based on math doesn’t mean they aren’t subjective. You determine the specifications of math-based indicators in the first place (such as how many days are in a moving average), and your specifications may contain preconceptions and bias.

When you interpret trading guidance from math-based indicators, you’re using judgment again. Math-based indicators may involve just as much personal judgment in design and application as outright judgment-based indicators.

Indicators are useful for identifying these five conditions:

  • A trend is beginning.

  • A trend is strong or weak.

  • A trend is retracing but will likely resume.

  • A trend is ending and may reverse.

  • A price is range-trading.

Each indicator works best in one situation and less well in others. Technical traders argue the merits and drawbacks of indicators in each situation, and the indicator you choose for each task depends, to a certain extent, on the security and also on your choice of analytical time frame.

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