Too many Technical Indicators?

When it comes to trading, more tools and techniques might not necessarily give you edge over the market. Instead, what you really need to know is what tool to use when. Although there's tonnes and tonnes of information available about all sorts of techincal and fundamental stock forecasting techniques, unfortunately there's very little information available on the internet on what indicator and tool to use when.

Here I intend to start a series of blogs to educate people on what indicator to use when. Most of the information that I am providing here is based on my understanding of various technical indicators. To understand what indicator to use when, one really need to go through the detailed mathematics that is involved in plotting the indicators. We will try to keep mathematics as far as possible because there's a lot of it already available on the internet. Instead we will try to focus on the essence behind the mathematics.

In this first article of this series, I will cover SMA.

In the next articles I will cover other indicators like EMA, RSI, MACD, ADX, Ichimoku, etc.


Simple Moving Average (SMA)

SMA is one of the most basic stastical tools. Note that I am not calling SMA as a "forecasting" tool. Instead I am calling it a "stastical" tool. The reason is that since there's a very suttle difference between both the terms because one is not really meaningful or useful without the other, at least in the practical world; people, and especially traders, tend to forget this suttle difference and start treating the indicators as "forecasted results". However, in reality they could be just "statistical results".

It's important to keep in mind that all the indicators like SMA, EMA, RSI, etc. are "statistical indicators". In order to "forecast", traders use these indicators and put their own human intelligence and logic to "forecast".

So, in essense, more indicators won't give you a surity of winning trades! However, if you know many indicators, and you know which indicators to use in which situations, you can possibly "forecast" better; and that would lead to winning trades.

So, let's come back to the main theme of this blog series; i.e. the indicators.

SMA, Simple Moving Average is computed by taking average of past data. Let's say if you have a series of numbers like:

1, 3, 2, 4, 6, 7, 4, 1, 1, 3, 4, 4, 5, 2, 5

And we want to find SMA(5), which means we will calculate simple moving average of last 5 periods, then the first SMA would be calculated as:

(1+3+2+4+6)/5 = 3.2

Second SMA would be calculated as:

(3+2+4+6+7)/5 = 4.4

And so on.

The idea behind SMA is that it gives an overall average of the movement of stock prices so that you can have an idea of the overall trend. Note that the values calculated by SMA are "not" forecasts. Instead they are just averaged out numbers of the past n periods so that you know what's the overall trend.

Note that first, in this series of articles, I'll first cover about each indicator and then go deeper into each indicator and then into discussions as to when to use what indicator and how... So hang in there and keep on reading. It's going to be a bit long journey. But if you really want to make money in trading, "no one time 5 page article will help you do that". So stop wasting time looking for such "strategies" and instead spend some time going through this series of articles.

Sorry for being blunt, but that's how trading is - cold hard - you eat or get eaten...

So coming back to SMA...

Above, we first understood what SMA is. Let's see how to use it to find "overall trend".

Above is a one year chart of Sun Microsystems (SUNW). This is a "Candle Chart" with a 15 period SMA (also written as SMA(15)) plotted as a red line. Note that the stock moves up and down with small triangular formations, but SMA helps finding the overall trend. Once we know the trend, we can find the "channel" in which the trade is moving and then if the trend is up, then enter into the trade at the bottom of the channel and take profit at the top. For people who don't know these terms like "channel", etc., hang in there and things will be more clear in the coming articles.

Also, in trading, since the stock quote is given in generally 4 figures (open, close, high and low), generally, the SMA line is plotted using the "open" values. This is because, traditionally stocks have been traded on the "long" side. In other words, traditionally people used to only buy stocks and hope for them to grow. There was no concept of "shorting" trades, because that requires margins and all, in which we'll go later. So, if the stock is growing, then plotting the "open" values gives you more room for making profit because overall on an average the stock would open at some price and grow each day (on average), so plotting on open values makes sense. This also gives you a hint on what price the stock will open next morning.

That's it for now. Hope you'll be able to digest this information. Feel free to send in your comments or questions and I'll be happy to answer as many I can and also include as many answers as possible in the coming tutorials in this series.