Indicators in technical analysis.
- Indicators along with chart patterns, trend lines, resistance / support levels etc., are an essential part of technical analysis.
- But there is a common misconception, that the use of indicators can predict the future price action.
- Logically, if one looks at the calculations of the technical indicators, they are based on the price movement, so they would obviously mirror the price movement.
- When price rallies, the underlying momentum in the price causes the indicator to rally as well, and the same applies when price starts falling.
- So why would one expect the indicator to predict the subsequent price moves, when it would mirror the price?
- Hence, very few indicators have characteristics which can be defined as leading.
Divergence
- One such characteristic is the “Divergence” set-up which is often considered to be an effective and leading indicator of price movement.
- Divergences occur when there is a discrepancy between the price and a technical indicator.
- We can define it as the failure of the indicator to confirm the higher high or lower low of the price. This discrepancy or divergence is usually observed on the oscillator type of indicators, such as the RSI, MACD, CCI, Slow Stochastic etc.
- (In fact, these oscillators give their most valid signals when their readings diverge from the price.)
- Hence an early indication of the change in momentum is given by the divergence set-up, and a change in momentum is often the primary indication for a shift in trend.
Sunil Mangwani 's presentation at the International Traders Conference (ITC), held in Barcelona in October '08
