Jun 16, 2008

Combining Technical Indicators - 2

As seen in the earlier post on "Combining Technical Indicators -1", it may not make much sense to use the technical indicators that measure the same underlying characteristics. For example, measuring Stochastics oscillator and RSI (Relative Strength Index), is redundant since they both banded momentum oscillators designed to measure overbought and oversold conditions. You should rather diversify your technical indicators too.

The question now is, what is a better combination of technical indicators. Here is one thought that I saw on stockcharts.com. Use one indicator from each category below so that you look at technical indicators in a more comprehensive way.

1. Momentum related: A momentum indicator used to identify potential overbought and oversold levels. Example: RSI, MACD, ROC

2. Volume related: A volume indicator is used to identify buying and selling pressure. Example: Chaikin Money Flow (CMF), Money Flow Index (MFI), On balance Volume (OBV), Accumulation/Distribution

3. Trend following Indicators: A trend-following indicator to identify the underlying trend in the stock. Example: Moving Averages, Directional movement System (ADX)

4. Price Relative: A comparative indicator to identify the strength of the stock relative to a major index.

Indicators from these four categories have little in common and complement each other very well.

-Nidhi

Related post:

Combining Technical Indicators - part 1