Do you want to gain an edge on the market?  Then you need to understand how to use stock market indicators.

The best way to learn about any indicator is to break it apart.  If you know how it works you will have a better understanding for when it should work.  Stock market indicators are built off of the price of the underlying security.   Each indicator uses this price information differently to calculate the indicator.  Moving averages, close price, low price, high price, rate of change in price are just a few ways the indicator may calculate the signal number.  Each of these price measures can give you a completely different signal.  You must understand the calculation of your indicator, to be able to trade off of its signals.

Not all indicators are created equal.  What this means is some indicators are good at identifying trends and other are better at identifying extremes.  These extremes are called overbought and oversold.  You need to be able to understand what type of indicator you are using to be able to identify the signal correctly.

It is very important to understand what type of trading system you are building before selecting your stock market indicator.  If you are building a trading system that is trying to catch the beginning or end of a trend then you would not want to use an indicator that is built to measure extremes.  Most trend following systems are looking for some type of breakout or breakdown.  Generally this will be the same time there is an extreme condition.

So you would not get the correct signal if you have the wrong indicator built into your system.  Same would be true for an extreme (reversal) trading system. This type of system is looking for an extreme condition where it signals a change in direction.  You would not want to trade it like a trend following system. For example, your trend indicator may be saying “buy” while your extreme (oversold or overbought) indicator may be saying “sell”.  You need to make sure the signal matches the system.

 

There are many different ways to use stock market indicators.  Some people use them as reversal indicators, selling when they are overbought or buying when they are oversold.  Then others use them to help them identify whether or not a trend is beginning or ending.  No matter how you use them you need to make sure the indicator and system match.