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Indices and oscillators

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Indices and oscillators comprise two distinctive groups of technical tools available to an analyst. A correct understanding of each group is crucial to successful market navigation. 

 

Key takeaways:

  • The index is a cumulative sum of data like price and volume.
  • Indices show absolute value changes.
  • Oscillators tend to perform well in trading ranges. 
  • Oscillators show relative value changes. 
  • Oscillators without boundaries also exist.

 

Indices

Indices are cumulative sums of data that are continuously measured over time. Indices are not limited to the boundaries like oscillators and show absolute changes. The relationship between the price trend and the index trend is more relevant than the value of the index itself. Indices' forecasting strength lies in spotting the divergence between the price and the index. Therefore, the use of indices is suitable for analyzing trending markets. 

 

The illustration shows the daily chart of gold (XAUUSD) between 2019 and 2022. The index below the price chart is called On Balance Volume (OBV), a common tool used by technical analysts. 

 

Oscillators

Oscillators are limited to specific past periods, and unlike indices, they tend to oscillate within certain boundaries. These opposing limits, called overbought and oversold, usually represent opposing conditions in the market. Therefore, an oscillator's value has interpretative meaning. The study of trendlines, channels, and patterns is applicable to oscillators, which can be used in both trending and non-trending markets. 

 

Overbought

When an asset is expensive compared to its relative past, it is considered overbought. On a graph, it is usually represented as an upper zone. The standard value for the overbought condition is 70 and above. 

 

Oversold

When an asset is cheap compared to its relative past, it is considered oversold. On a chart, it is represented as the lower zone. The standard value for the oversold condition is 30 and below.

 

The image above depicts the daily chart of the Nasdaq continuous futures (NQ1!) and the Relative Strength Index (RSI), a bound indicator that tends to travel between oversold and overbought zones, indicating when an asset is relatively cheap or expensive.

 

Leading and lagging indicators

Technical analysis differentiates between leading and lagging indicators. Leading indicators are observable variables that predict a change in another variable with which they are correlated. Contrarily, lagging indicators trail a change in another variable with some latency, making them useless for predicting the market. Instead, they are used to confirm the prevailing trend. 

 

Crossover

A crossover occurs when an oscillator crosses over a significant level or crosses another oscillator. Important values are often represented by numbers such as 0, 30, 50, and 70. Other significant values can be either in the middle of the scale or near the boundaries of an oscillator. A trend is typically bullish when an oscillator moves above 0. When it moves below 0, it is generally considered to be bearish. Mechanical traders favor crossovers because they are easily observed, and their implementation helps avoid emotions that could potentially interfere with the trader's decision-making.

 

The picture displays the daily chart of Bitcoin (BTCUSD) and RSI. White arrows indicate crossovers into and from the overbought zone. 

 

Divergence

The divergence between the price and an indicator can be positive or negative and has various interpretations, depending on the tool of choice. A positive divergence occurs when the price moves lower, and an indicator moves higher or shows bullish signals. A negative divergence occurs when the price moves higher, and an indicator moves lower or exhibits bearish signals. 

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