Choosing the Right Indicators to Fit Your Trading Style
The type of technical indicators that traders choose can be crucial to the analytical insight they want to attain in the process. At the core, mathematical calculations all display price movement of assets in a different way than just watching price changes. Reviewing closing prices is a common approach but there are more nuanced ways of assessing an asset.
How Traders Use Technical Indicators
Technical indicators usually have several settings that can be configured by the trader to modify the way the indicators are displayed. These data points typically correspond to a chart's price bars, which are composed of an open, a high, a low and a close. When traders use an indicator, they can choose which of these data points to apply in their calculations.
Instead of using data points in that fashion, traders can choose a setting that takes the average of the open, high, low, and close. This is also known as the OHLC Average. The high, low, close average (HLC Average) is also common in many trading platforms. In some charting and trading platforms, the close price is referred to as the "last" price. The attached chart shows these options in the settings menu of an indicator. Other options may also be provided, depending on the indicator.
Types of Trading Indicators
The closing price is a common setting for indicators but there may be situations where using the open, high, low, or an average provides better insight.
For example, during an uptrend, if a trader is watching for price bars dropping below a moving average (MA), then using the low of each candle as the input for the MA may make more sense than using the close. This way, the moving average is only breached when a price bar penetrates the average lows of other price bars. The same concept could be applied during a downtrend and using price bar highs to calculate the moving average. This is not a requirement, only an example of how settings can be altered to achieve alternative insight. While differences are often minor, if an indicator is used to provide trade signals, the input data will have a direct impact on the profitability of those trades signals.
OHLC and HLC Averages
The average of the open, high, low, and close (OHLC) for a given time frame is the average value of the opening price, the highest price that was reached, the lowest price that was reached, and the closing price. For example, a candlestick or price bar may have an open of 68, a high of 85, a low of 66, and a close of 72.
The calculation of the open, high, low, close average is calculated as follows:
OHLC Average = (68 + 85 + 66 + 72) / 4 = 72.75
The HLC Average is much the same except the open price is excluded, and the sum of the high, low and close are divided by three.
HLC Average = (85 + 66+ 72) / 3 = 74.33
Though the resulting averages are comparable, this shows how changing the parameters of the data being input affects the calculation of the indicator.
Choosing the Right Indicator
Experiment with different settings for any indicator that you use. Select the settings that work best for your analysis and trading style.
To experiment with input data, place several versions of the same indicator on the same chart. Change the input data for each one, so you can visually see how the input data change the indicator. If necessary, change the color of these various indicators so you can tell them apart. Select the setting(s) that provides the best insight for the strategy or analysis method you are using.