Hi There
This is a quick and dirty explanation of what technical indicators are, for those who are not already familiar. Does the term sound intimidating? Maybe a little, but the concept is really very simple.
Break It Down
Let’s look at the two pieces of the term: “technical” and “indicator”.
When we say “technical”, we mean that people are relatively uninvolved in this analysis, and computers are going to be doing most of the work. Computers run algorithms, and algorithms typically look for patterns.
When we say “indicator”, that means that we have given the computer a set of conditions that indicate that something is happening. What exactly is happening? Well, that depends on the algorithm.
To put them together, a technical indicator is a computing process that raises a signal when it thinks something important has happened.
Inputs and Outputs
“But what in tarnation does the computer look at?” you may ask. The answer is any historical data related to an asset. This may be the price of the asset, volume, open interest, etc. This differs from fundamental data, like profit margins, revenue, and earnings. Algorithms will often look at this data over long time periods; weeks or even years into the past.
“And what on earth comes out of it?” you ask, poking the computer with a ballpoint pen. The answer: anything! But the result of a technical indicator often falls into one of two categories: a buy signal or a sell signal. Put simply, does the algorithm tell us that it is a good time to buy or a good time to sell?
In the Real World
The most common use of technical indicators in the real world is by complex financial models that are used for trading stocks at high rates. Technical indicators are almost never used in isolation. Most often, many indicators are composed together to form a model. A collection of dozens or even hundreds or thousands of indicators decide together on buy and sell signals. It’s not unusual for these models to execute trades, too, without any human input!
An Example
One very popular technical indicator is Bollinger Bands. These are a type of adaptive trading band that deliver a collection of useful signals using just historical price data:
Overbought: the stock price is probably higher than it should be.
Oversold: the stock price is probably lower than it should be.
The Squeeze: volatile times are ahead.
Read more about Bollinger Bands!
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