How to Classify Stock Market Indicators - dummies

How to Classify Stock Market Indicators

A market indicator is 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. You use indicators to clarify and enhance your perception of the price move.

Indicators aren’t like ice cream with a million different flavors. You can classify your indicators easily because 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. These indicators can be time consuming to master and use. They’re also hard to translate into software formulations so that you can backtest them to see how they would’ve worked over the price history of your security.

  • Math-based indicators: The math group includes moving averages, regression, momentum, and other types of calculations. Expressing chart events in mathematical terms allows you to backtest the event over historical data to discover how well it predicts the next price action.

    If math isn’t your cup of tea, don’t worry. The math involved in most technical analysis isn’t all that difficult (except up in the stratosphere of advanced technical analysis). You can apply math-based techniques without understanding the math behind them as long as you understand the crowd behavior the indicator is identifying and how to apply the indicator. Think of it as knowing how to drive a car without being able to build a carburetor.

You may prefer to jump straight to math-based indicators because they’re faster, cleaner, and “scientific.” But math-based indicators do the same job as judgment indicators — they display price data in a specific format to assist you in making a trading decision. Just because they’re based on math doesn’t mean that 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). Visual recognition and math-based techniques are equally valid and useful. Some traders use only visual-recognition techniques, some use only math-based indicators, and some use both.