The latter focuses more on the financial position of a firm along with prevailing economic conditions. Technical indicators see extensive use in equity and forex markets. They help study how price movements in the past emulate the future. There has also been an increase in the complexity of new indicators. With additional computing capabilities, indicators are now able to track price movements down to the second. Doing so enables traders to act faster and more efficiently.

What is a technical indicator?

A technical indicator is a mathematical approach to understanding how the price of an asset might move. The inputs include historical price, volume, or open interest in the case of derivatives. The indicator is generally plotted over a chart and the trend is used by traders to estimate how price could behave in the future. As a trader you can customize most of these indicators according to your personal needs.

While these indicators offer a simple way of identifying trends, you’ll need test them first to assess their capabilities. This is particularly important since many existing indicators keep getting constant updates. Traders also create new ones every day. One way to check the accuracy is by back testing. This is a process in which you compare the actual results to what the indicator itself predicts. If both the results are in tandem, then the indicator may be considered effective. If that’s the case, it could be useful for making  investment decisions.

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Types of technical indicators

Indicators can be classified in several ways based on whether they are tracking price or other metrics. Generally speaking, you can sort them into the following four categories:

Trend Indicators

This shows whether there is a trend in the price of an asset. It helps traders understand if the signal is strong or whether they’re seeing a possible price reversal. The Moving Average Indicator (MA) is the most popular trend indicator.

Momentum Indicators

A more advanced form of a trend indicator, momentum indicators help to quantify the strength of a trend. It helps determine whether an asset is overbought or oversold.  The Relative Strength Index (RSI) and Moving Average Convergence/Divergence (MACD) are the two popular momentum indicators.

Volume Indicators

Volume indicators use the volume of trades, how frequently these assets are bought or sold. Often complimented with trend/momentum indicators, they help to substantiate the results from the other indicators. The Volume Oscillator is an example of a volume indicator. 

Volatility Indicators

Volatility measures the deviation of price from its average. Higher volatility indicates that price has been fluctuating a lot and you can expect it to settle down in the future. In particular, the Bollinger Bands indicator is one of the most common and widely used volatility indicators.

Some commonly used technical indicators

While there is a wide array of technical indicators that can be used, we have listed a few that are commonly used and can be easily understood.

Moving Average Indicator

It is a trend indicator and is one of the most widely used technical indicators. It plots the price of a share along with the average price over a certain period. The average price can be for a few days or you can customize it and reduce it to even just a few minutes. The chart below shows the 14-period (day) weighted moving average plotted against the price of the S&P 500 E-Mini.

As you can see on the chart, on many of the occasions when the price line has crosses over the moving average line, it results in a trend reversal. This is also referred to as a crossover. As a trader you can customize the indicator’s time span depending on whether your interest is trading short-term or long.

Moving Average Indicators are also used to determine the resistance or support point. In an uptrend, a 50-day MA, 100-day MA, or 200-day MA can be used to determine the support level. You can make similar observations for resistance levels in a downtrend. MA indicators are lagging in nature, since they depend on historical prices.

The Exponential Moving Average Indicator depicted in the image is an advanced version of MA. It puts more weight on recent prices when calculating the average. This helps to account for the most recent price thereby reducing the lag that we generally observe in Simple Moving Averages. 

Relative Strength Indicator

The RSI is a common momentum indicator ranging between 0 and 100. A value above 70 suggests that the share is overbought and there could be selling pressure in the future. An RSI of below 30 indicates it’s oversold and that there could be an increase in price in days to come. The mathematical formula for RSI is:

RSI = 100 – 100 / (1 + RS)

RS stands for Relative Strength. It measures the average return of the up-move divided by the average returns of the down-move. In a 15-day RSI, if there are 10 days of gain with an average gain of 0.5% and 5 days of loss with an average loss of 0.25%, then RS is 2 and RSI is 67%.

The chart below shows the classic 14-day RSI for the S&P 500 E-Mini.

Unlike MA indicators, you need to plot the RSI in a different section since the scales are different from that of price. The two dotted lines represent overbought and oversold levels. In numerous instances price fell every time the RSI breaches a value of 70. You can also reduce the time frame to a few seconds instead of 14 days for more dynamic trading. Traders also change the overbought level to 90 and oversold levels to 10 to gain more confidence in the results.

Volume Oscillator

Price indicators may sometimes produce results that don’t necessarily reflect the real picture. In periods of consolidation when prices are relatively flat, price indicators may not be reliable. Similarly, when there’s no heavy volume to back up the price fluctuation, the changes in price may not be sustainable. Volume indicators give credibility to the results obtained from other indicators.

The Volume Oscillator is one such indicator. Here’s how you calculate it:

Volume Oscillator = [(Simple Average of Volume Traded for Shorter Period – Simple Average of Volume Traded for Longer Period) / Simple Average of Volume Traded for Longer Period] * 100

The chart below shows the Volume Oscillator where the longer period is 10 days while the shorter period is 5 days.

In the above chart, we don’t see a distinct pattern to suggest that the volume oscillator could substantiate the the uptrend we can observe. This would have been conclusive if the oscillator points were consistently above 0%. Nonetheless, you can’t write off the indicator. It is best to use it along with other technical indicators. 

Bollinger Bands

It is a type of volatility indicator which uses the Simple Moving average and volatility as inputs. The following three lines make up the band: an n-period Simple Moving Average line, an upper Bollinger Line, and a lower Bollinger Line. The upper line is generally two standard deviations above the Simple Moving Average while the lower line is two standard deviations below. Standard deviation is a measure of volatility. Therefore we can consider Bollinger bands volatility indicators. 

Upper Bollinger Line = Simple Moving Average + number of standard deviations * volatility

Lower Bollinger Line = Simple Moving Average – number of standard deviations * volatility

As the lines come closer, it means that there has been a reduction in volatility. Prices close to the lower Bollinger band could signal an oversold situation signaling traders to buy. Many experienced traders recommend that you analyze trends while studying the patterns of Bollinger Bands.

There are other technical indicators like Moving Average Convergence/Divergence that provide useful insights but maybe a bit complicated to understand. Hence, beginners should first get a grasp of the basic ones and try to apply these in real scenarios. Users can open a virtual account to  put their knowledge to the test for example. Many retail brokers will provide these accounts without any additional charge.

Conclusion

As trading systems evolve, trading indicators have been relied on to provide signals that are more dynamic in nature. Traders are now looking at parameters that can provide information every second. Even long-term investors who rely on fundamental analysis look at technical indicators to gauge the market sentiment. Indicators have become complex, and we advise traders to exercise judgment and not rely solely on a single indicator. 

The post Technical Indicators for Beginners and How to Use Them appeared first on Earn2Trade Blog.

This article will show you how the Aroon Indicator is calculated and help you understand how traders can interpret its results to execute trades based on the indications given by these lines.

What Is the Aroon Indicator?

The Aroon indicator consists of two lines: Aroon Up and Aroon Down. The indicator generally has a 14-period (typically days) timeframe for determining the up or down line. Although 14 is the default, setting the indicator for longer time periods is also possible. Setting the indicator to 25 periods is not at all uncommon.

The Up line determines the number of periods we’re away from a high in the corresponding 14-period time frame. Likewise, the down line measures the number of periods we are away from a low.

It was developed by Tushar Chande in 1995, and it means dawn in Sanskrit. It essentially looks to detect the beginning of a trend or a change in trend, and its name reflects that.

The chart above represents a 14-period Aroon on a daily chart. The blue line is Aroon Up, and the orange one is Aroon Down. The Aroon can also be viably used even on charts with one-minute candles. Smaller time periods are generally preferred for traders who trade more frequently and hold their positions for a shorter time.

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Aroon Indicator Formula

The Aroon Up or Down determines how long it has been since the last high or low for the current period. The Up or Down values are expressed in percentages and range from 0%-100%. The closer the line is to 100%, the stronger the trend. For example, an Aroon Up close to 90% would indicate a strong uptrend. However, this also has to be accompanied by a low Aroon Down Line to give us confidence in the trend. On the other hand, having the Aroon Down close to 100% simultaneously would also mean a low not long ago.  

You’ll find the formula for calculating both lines below. For the sake of simplicity, let’s assume a 20-day period.

Aroon Up = (20 – No. of days since 20-day High) * 100 / 20

Aroon Down = (20 – No. of days since 20-day Low) * 100 / 20

Suppose you want to calculate the Aroon Up value today. We need to determine the point in time when the price was highest in the last 20 days. If that was 2 days ago, then we can use the following equation to find the Aroon Up:

Aroon Up = (20 – 2) * 100/20 = 90

Likewise, if the high were 15 days earlier, the value would be 25. The closer the 20-day high is to now, the greater the Aroon Up value is. This can be interpreted as an uptrend if there is also a low Aroon Down value (typically less than 50%) to confirm it.

How to Use the Aroon Indicator?

Now that we know how to calculate the Aroon Indicator, it would be good to illustrate its use in a practical scenario. Take a look at the highlighted part of the chart below to see an example of a signal provided by the crossover between the up and down lines. 

Whenever there is a crossover, it indicates that a trader can expect a reversal in the trend. In this case, the down line crossed over the up line and hit the 100% mark. Before this, there was an uptrend in the price, and the crossover indicated that the prices would drop. The indication turned out to be true as we see the price falling continuously for a few days.

The chart also shows numerous cases where the lines move in tandem. One such instance is highlighted below.

In this case, both the Up and Down line trend downwards indicates no specific price trend. Looking at the trend, we can see a period of consolidation where the price is almost flat. In a phase of consolidation, there’s a chance that any small move may significantly impact the Aroon Lines because the highs and lows are close to each other. 

Aroon Lines could, therefore, be used by traders to forecast any buying or selling opportunities depending on the strength of each line. If an Aroon Up is above 50% and Aroon Down is below 50%, it could indicate an uptrend. When both the lines are close to each other, there is no definite trend. 

Setting Up the Aroon Indicator

Many platforms like Finamark have a dedicated section for technical indicators, as highlighted below.

On opening that menu, there is a range of options to choose from. Search for Aroon and add it to the list of Active Indicators. This indicator may not be available on all online platforms. 

Most platforms give traders the option to choose the time interval for calculating the Aroon Lines. There are options to trace the Aroon Lines based on a 1-second period for someone looking to benefit from short-term trades. Those aspiring to trade less frequently can opt for a longer duration, like 1 week.

The smaller time interval offered by Finamark Systems gives an advantage to traders who are keen on trading very frequently. It enables them to trace the signal beforehand, which would not have been possible had the interval been longer.  

Advantages and Disadvantages

Advantages:

• Easy to comprehend – Interpreting the lines can be relatively simple and does not involve complex mathematical expressions.
• Effectively signals changes in trends – Line crossovers can signal an increase or loss in momentum to the traders.
• Flexibility in choosing the interval – Traders can change the length of the time period for calculating the Aroon Lines based on how frequently they trade.

Disadvantages:

• Lagging indicator – The Aroon Lines are based on historical prices, so they will form with a delay compared to the underlying trend.
• Influenced more by time than price movements – Since it depends only on how long ago the last high/low was witnessed, the indicator does not provide any information on the magnitude of change that could take place.
• Should be used in conjunction with other indicators – On a standalone basis, the signals provided may not always be accurate, and it is always better to use them in tandem with other indicators.

Differences Between Aroon Indicator vs. Aroon Oscillator

Aroon Oscillator can be considered an extension of the Aroon Indicator and measure how strong or weak the trend is. The Aroon Oscillator, in other words, confirms whether the trends that can be seen building up in the Aroon Lines should be used to interpret if there is a valid trend. The Oscillator is the difference between Aroon Up and Aroon Down, and the range is from 0%-100%. When it is close to 100%, a trader can be confident in the signals coming from the Aroon Lines.

Earlier, we mentioned that a high Aroon Up and a low Aroon Down would imply that an uptrend is around the corner. The Oscillator, in this case, would also generate a high value, which would confirm our estimates. In short, the Oscillator is just a way of telling us how confident we should be of the Aroon Indicator.

Which Indicator Works Best With Aroon?

The Aroon Indicator does not give any hints on the magnitude of the move that could take place. So, there could be other indicators you could use in addition to it. The Aroon Oscillator, for example, could be useful for a preliminary analysis. Price action should also be used in conjunction with the Aroon since the lines may not necessarily react quickly enough to predict a downtrend. Often, the crossover between the Up and Down lines only happens while we’re already in the middle of a significant upwards or downwards move. Many different chart patterns prove useful in predicting the future price of a share. Patterns like triangles and the like could be used along with Aroon Lines to confirm your technical analysis conclusions. These patterns generally are more predictive in nature and could give traders an advantage by keeping them ahead of the curve.

F.A.Q

The post Aroon Indicator – How to Use It? Definition, Formula and Settings appeared first on Earn2Trade Blog.

What is The Exponential Moving Average?

Exponential Moving Average or EMA is an advanced version of the simple average that weighs the most recent data points while calculating the average for a particular day. By focusing more on the latest data points, the EMA ensures that the old and redundant data points do not have the same influence on the indicator as the latest data point. This is different from calculating the simple average, where all data points have the same weight.

The disadvantage of a simple average is that it might not give you a number weighted too heavily on old data. In many cases, that’s not the most accurate figure. For example, if a company’s earnings result shows that it beat Street estimates, that may lead to a surge in price. A simple average indicator would not capture that momentum adequately. One would have to wait for a few days before it would actually reflect this information.

On the other hand, the EMA would be more responsive to such changes by placing more weight on the latest developments in price. A trader can customize the weight the indicator needs to assign to the latest data point based on their importance to the latest figure. It is this particular feature that makes EMA a more effective tool than the simple average.

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Exponential Moving Average Formula

EMA_t = Closing Price_t * multiplier + EMA_t-1 *(1 – multiplier)

Here “t” denotes the instant for which the EMA needs to be calculated, and “t-1” is the previous instant.

The formula for the multiplier is the following:

Multiplier = Smoothing Factor / (1 + number of days)

So, if you want to put more weight on the latest data point, you can do it by increasing the smoothing factor and decreasing the number of days. The next section will tell you how to use the exponential moving average formula to calculate an actual EMA using different inputs, namely the closing price, smoothing factor, and the number of days.

Exponential Moving Average Calculation

Let us develop the EMA profile of an asset from scratch. Some of the parameters we need to define first are the smoothing factor and the number of days. If we need to calculate the 50-day EMA, we would require 51 data points. The simple average of the first 50 data points would be the EMA_t-1 in our first iteration since we do not have a history for the EMA. We would process it by using a smoothing factor of 2. First, we need to find the multiplier based on these two inputs.

Multiplier = 2 / (1 + 50) = 0.0392

Now, if the simple average of the past 50 days was 100 and the closing stock price today is 125, the EMA would be calculated as:

EMA = 125 * 0.0392 + 100 * (1 – 0.0392) = 100.98

Now we have an EMA to work with and will no longer have to rely on the simple average to determine the subsequent EMAs. On the 52^nd day, we assume the price to be 130, and the EMA would be calculated as:

EMA₅₂ = Price₅₂ * 0.0392 + EMA₅₁ * (1 – 0.0392) 

EMA₅₂ = 130* 0.0392 + 100.98 * (1 – 0.0392) = 102.12

However, it should be noted that a weight of 0.0392 may seem somewhat small for calculating the exponential moving average. However, it is higher than the weight a simple average calculation would put on it. In our case, in which we are considering a span of 50 days, the weight for a simple average for all the data points would be 1/50 or 0.02.

How Does The EMA Work?

As we have highlighted earlier, the EMA focuses more on the current price point. An investor can adjust the two variables, smoothing factor and number of days, to change the multiplier. We will illustrate the impact of changing these two parameters on our assumptions in the previous section.

Scenario 1: Change smoothing factor to 1.5 keeping number of days constant

Multiplier = 1.5/51 = 0.0294

EMA₅₁ = 125 * 0.0294 + 100 * (1 – 0.0294) = 100.74

EMA₅₂ = 130* 0.0294 + 100.74 * (1 – 0.0294) = 101.60

Compared to our base scenario in which EMA₅₁ and EMA₅₂ were 100.98 and 102.12, we can observe that reducing the smoothing factor underestimates the EMA when the price is constantly rising.

Scenario 2: Change number of days to 25 keeping smoothing factor constant

Multiplier = 2/26 = 0.0769

EMA₅₁ = 125 * 0.0769 + 100 * (1 – 0.0769) = 101.92

EMA₅₂ = 130* 0.0769 + 101.92 * (1 – 0.0769) = 104.08

Compared to our base scenario, we’ll see that reducing the days improves the accuracy when the price is constantly rising. 

Scenario 3: Change both number of days to 25 and smoothing factor to 1.5

Multiplier = 1.5/26 = 0.0577

EMA₅₁ = 125 * 0.0577+ 100 * (1 – 0.0577) = 101.44

EMA₅₂ = 130* 0.0577 + 101.92 * (1 – 0.0577) = 103.09

Compared to our base scenario, we observe this is more responsive since reducing the count of days has a higher impact than reducing the scaling factor.

So, in short, we have to reduce the number of days or increase the scaling factor to ensure that maximum weight is placed on the latest data points. These adjustments can be made, especially when observing a breakout and old data points with less predictive capabilities. Traders who are into short-term trading can reduce the time considerably to detect trends faster. 

How to Use The Exponential Moving Average

A moving average trend is plotted alongside price to determine the trend. Normally a set of EMA trends is used to enhance the efficiency of a technical indicator. These sets of EMA trends are called the ribbon. The shorter the period, the more responsive the ribbon is to the current price. For example, ribbons using 10, 20, 30, 40, and 50 days would be more responsive than ribbons using 150, 160, 170, 180, and 190 days. The chart below shows the 10-day (blue line), 20-day (orange line), and 30-day (pink line) EMAs for the S&P 500 E-Mini.

We see that the 10-day EMA seems to track the latest price more accurately and is more responsive to any significant changes in trends. Some of the ways traders can use the EMA ribbons include:

• When ribbons converge to a single point, it could indicate a reversal in trend.
• When the shorter EMA crosses below, the longer moving averages we can expect a downtrend. Likewise, when the shorter EMA crosses above longer EMAs, we can expect an uptrend.
• When the ribbons are spread far apart, we can expect a trend to develop This can be an uptrend or a downtrend.

All of the signal types mentioned above have been marked on the chart above. For example, the point marked “a” shows the 10-day, 20-day, and 30-day EMAs converging, and we see a reversal in trend. The price that was rising is now in a downtrend at that point.

What is The Difference Between Simple and Exponential Moving Average

The fundamental difference between the two is that the weight it attaches to the latest data points. You can find a table on a few additional difference below:

Investors generally favor EMA over SMA due to the features that have been discussed. Many of them still use the SMA as a reference in many cases since it is a simple tool that is easy to understand.

EMA Strategies

Like we said before, the ability to fine-tune the parameters in the multiplier makes EMA an effective tool. Numerous strategies have been developed to perform technical analysis. The basic idea is to compare the trend of a short EMA with that of a longer EMA. These strategies have been used in different asset classes, namely equity, commodities, foreign exchange, and even cryptocurrency. We will discuss two of the common trading strategies that traders use to determine the price movement and how traders can interpret the interplay between a short EMA and a long EMA.

EMA 12 and EMA 26 trading strategy

The EMA 12 and EMA 26 trading strategy is one of the most common and simple strategies used by traders. While we have demonstrated our previous example using days as our unit of time, the period can be more granular. For example, in this case, we could use 12 minutes and 26 minutes as our frames of reference. 

We can take a live example using the S&P 500 E-Mini once again. The blue line is the EMA 12, and the orange line is EMA 26.

We have labeled two points as “A” and two points as “B” on the chart above. You can interpret them as the following:

• In the first “A,” we see the two lines converging, and the EMA 12 falls below the EMA 26, which should have signaled a downtrend. The opposite happens in the second “A” as the EMA 12 crosses above EMA 26, and an uptrend follows.
• The two “B” marks illustrate a phase in which there is a continuation in the trend. The first one demonstrates a continuing downtrend, while the second one shows a strong uptrend. Wider lines should indicate a stronger trend in the asset that we’re tracking.

While such technical indicators serve as a useful tool, it should not be used in isolation. For instance, the actual result may vary from what these tools indicate. In addition, it’s imperative to establish a stop loss as well.

The 5 EMA and 8 EMA crossover strategies

Another common strategy that traders use in especially dynamic markets is the 5 EMA and 8 EMA crossover strategy. Since we are using the 5 EMA and 8 EMA, you can expect this strategy to be highly responsive. That can make it an effective tool in volatile markets.  Using the same S&P 500 E-Mini market, we will explain how to use this strategy to enter or exit a position.

The purple line is the EMA 5, and the orange line is EMA 8. We have highlighted two crossovers in the above chart. We should note that these lines are very close to each other since the time interval is relatively small compared to the example we had illustrated earlier. 

Crossover “A”

• The EMA 5 is above the EMA 8
• This could be a signal to enter, so you should also keep a close eye on the price
• If the price is above the EMAs, that makes the signal stronger
• An uptrend follows

Crossover “B”

• The EMA 5 falls below the EMA 8
• This could be an indication to short, but price should also be taken into account
• If the price is below these EMAs, that makes the signal stronger
• A downtrend follows

Since the time intervals are minimal, these trades can be hazardous, and one should establish a stop loss to execute a trade. The chart also illustrates numerous instances of crossovers during which the rate is range-bound. In these cases, it may be essential that we also rely on price action for confirmation.

Pros and Cons of The Exponential Moving Average

Advantages

Out of the many technical indicators available, the EMA is one of the simplest. It is a favorite of many successful traders. The flexibility it offers in adjusting the smoothing factor or time period makes it a versatile tool. Traders can use it for long-term trades by adjusting the EMA for a longer period. In markets like FX, where the indicator needs to be reactive to the latest price, traders can simply reduce the time interval. The indicator works particularly well in a trending market. If used well, it can lead to a substantial profit for the trader. You can also customize and apply it to a wide range of asset classes as well.

Disadvantages

There are some disadvantages to it as well that a trader should be wary of. Since it attaches more importance to the latest price points, the indicator could send out false signals in a range-bound market. Like most indicators, the dependence on stale data points may be high for the EMA as well. In some cases, this can hamper the predictive ability. The trader might only catch a change in trends with a significant delay. This could lead to them missing out on a good opportunity. It is necessary to enhance the analysis using other indicators and price action. Establishing a stop loss is also a must in trading since the loss could be significant when leverage is used. There is also no way to decide which EMAs should be used in determining an optimum crossover strategy.

Today the EMA is still a useful tool for traders. It continues to see common use even though many more sophisticated technical indicators have cropped up since. The flexibility it offers and the simple computational requirements make it a handy tool in conducting analysis at a fast pace.

F.A.Q

The post Exponential Moving Average (EMA) Explained – Strategies and Tips appeared first on Earn2Trade Blog.

What is Scalping in Trading?

Scalping is a trading strategy commonly used by traders who look to pursue small profits through marginal movements in the price of a stock. The trader exits the position when they achieve the target price without keeping the position intact for further gains. Scalpers generally have a strategy to exit an unfavorable trade at a moment’s notice. Such an exit plan is necessary to keep the profit intact in case their trades go against them. A scalping strategy works only if the number of trades with profit outnumbers the number of trades with losses. 

This is a contradiction to traders who enter a position with a longer time frame in mind. That’s because the latter tend to maximize the profit on each individual trader rather than optimize the frequency of their successful trades. It is also necessary for a scalper to predict the movement in the correct direction, just like any other trader. However, the exact size of the price movement won’t matter quite as much. Scalpers also need access to appropriate trading infrastructure to make the strategy lucrative. 

How Scalping Works

We can consider scalping a more dynamic form of intraday trading. The trader executes hundreds of trades in a single day. The risk scalpers take on any one trade is typically small, and they close their positions quickly regardless of the profit from it. Some of the common features of scalping include:

1. Trading on small movements in price: Even when there may be a possibility of a large price swing, tend to consider it a safer bet to just close the trade while they’re ahead.
2. Positions held for a short period of time: The target price for scalpers is typically close to its current price and achieved within a few minutes. Scalpers also need to ensure that they limit the downside risk by closing the position before the movement reverses.
3. Liquidity is essential for scalpers: To execute a high number of trades within a short span of time, scalping needs liquid assets. For illiquid assets, the volatility and spread are generally higher, which does not match the risk appetite or trading strategy of a scalper.
4. Access to a real-time trading platform with minimal latency: A scalper needs to execute their trades immediately to take advantage of the minor deviations in price. It is vital for their bottom line to not have a bit of lag potentially erase all their profit.
5. High trading costs: Since the number of trades is high and the profit per trade is small, a scalper would need to cut down on trading costs, especially commissions, to improve their bottom line.

Spreads in Scalping

One of the ways scalping works is by exploiting the bid-ask spreads. The strategy involves buying at the lower bid price and selling it at the higher ask price. This is a relatively simple (but not easy) way to make a profit. These spreads are relatively stable and can generate a small profit that adds up for a scalper. However, it should be noted that price differences when using this strategy are tiny, and the spread could adjust to lower levels if this strategy is implemented by several traders. In such a case, the profits would not cover the commissions and other trading costs.

Scalping Trading Strategies

There are a few trading strategies that employ scalping with the help of technical indicators listed below:

1. Exponential Moving Average (EMA): When the price is above the EMA, it would indicate a signal to short the stock, and if it is below, the signal is that of a buy. A trader relying on scalping would have an EMA that is of a shorter duration. In most cases, traders use multiple EMAs together to decide on a trade.
2. Volume and price action: This involves studying the volume and price patterns. If the volume is high and the price is rising, it indicates a strong uptrend, and a scalper would go long on the stock. If volumes are low, it could be an indication of a reversal in trend.
3. Bollinger Bands: Bollinger Bands are lines that give an indication of the volatility of the price. If the price is below the lower band, it is a signal to buy. Similarly, if the price is above the upper line, it is a signal to sell.

A scalper could deploy the same or different technical indicators to a standard technical trader while performing trades. What distinguishes the scalper is that the intervals set for these indicators are very small. This makes it a very dynamic approach to trading.

Is it Better as a Main or Complementary Strategy?

Many traders use scalping as their main trading strategy. However, it should be noted that it requires a lot of experience and efficient and responsive trading tools. Making scalping their primary strategy requires an extremely high rate of successful trades. That means the number of profitable trades needs to outnumber their losses. One also needs to understand that scalping is a stressful technique that requires a remarkably high level of attention during trading hours. An opportunity could vanish within a few seconds if the trader is not vigilant enough. Most people turn to scalping only after having significant experience in trading. 

For most traders, it is advisable to take scalping as a complementary strategy. Understanding the markets before scalping ensures that the trader is aware of the risks. Many non-scalpers tend to hold their positions for a long time. While this could generate higher profits, the potential losses tend to be higher if the trader isn’t using stop-loss orders in a way compatible with the strategy. Making it an alternative strategy also ensures that one does not have to keenly observe the markets for a long period of time. The trader can select a specific period to indulge in scalping and pocket the gains, thereby keeping stress levels in check. 

Scalping as a Complementary Strategy

Scalping has been popularly used as an add-on strategy by many traders to boost their profitability. While trading short-term works best when volatility is higher, scalping can be used when the price of a stock is trading range-bound.

For example, consider a trader having shares of ‘Company A’ with a long-term view. If the price toggles between $10 and $11, then the trader can go long at $10 and sell it at $10+ or go short at $11 and square it off at $11-. While his original portfolio remains intact, scalping enables the trader to book incremental profits. One advantage that such a strategy carries is that the trader is already aware of the behavior of the stock and would know when to enter and exit. By deploying it as a complementary strategy, the trader does not have to execute a high number of trades, and the tolerance for misses is also higher. 

Scalping can also be used in umbrella trades for traders with a long-term view. In this scenario, the trader buys a stock and sells it as the price increases. Later, they repurchase it again at a lower price.

Another advantage of using it as a secondary strategy is that the scalper does not need to invest heavily in trading platforms for superior execution of trades.

How to Become a Scalper

To become a successful scalper, it’s essential to understand the market and the underlying asset you plan to trade. Most scalpers rely on technical analysis before entering a trade. That’s why knowledge of technical analysis tools is also vital. The strategy relies on the trader’s ability to accurately predict price movements. That’s why a scalper should backtest their performance using a simulator first. This helps determine how successful the scalper is in executing their strategy. Many online platforms offer courses in scalping strategies that can be used during the learning phase. Understanding the cost structure of trading platforms is also essential to determine how this strategy can break even. As mentioned earlier, experience is crucial to scalping. Anyone looking to make a decent profit should be willing to absorb the risk and stress that comes with it.

Using It for Different Assets

Most of what we’ve discussed so far was mainly based on stocks. However, scalping has seen popular use across a wide range of asset classes. These include derivatives like futures or holdings like foreign exchange (forex) and stocks. Scalping has also been used by some in the volatile cryptocurrency market. The best thing to do for each trader is to apply it to the particular asset they specialize in if they have one.

For example, if a trader specializes in foreign exchange, he could have a specific set of currency pairs for scalping. Sticking to one asset ensures that the trader obtains a high level of specialization, improving their accuracy and success rate. Within each asset, the level of risk is also significantly different. Scalping in the cryptocurrency market can involve a much greater risk given how volatile the movements in price are. This can lead to a major loss within a few minutes of trade. The same could apply to a currency pair that is relatively illiquid or is sensitive to economic factors. 

Scalping Futures

Using scalping for futures trading is a high-risk and high-return strategy. One needs a reasonable level of expertise before entering such trades. Futures on foreign exchange or stocks can be purchased to close out the position after garnering small profits. By putting an initial margin, a trader can gain exposure to a higher volume of assets, thereby maximizing their capital efficiency. The futures market is generally liquid, allowing for low margin traders, which lets a scalper exit their position quickly.

Scalping Forex

Using foreign exchange as an asset for scalping is common among traders. They generally use technical indicators to determine the correct time to enter and exit a trade. Many currency pairs are very liquid and offer plenty of opportunities to implement trades quickly. Scalpers can also take advantage of the bid-ask spread to profit. It’s worth noting that the movement in forex markets can be limited. Traders could have to take on a considerable position to generate even a small profit. Many scalpers also venture into currency pairs that are illiquid in nature or ones that have a larger bid-ask spread. 

Scalping Stocks

Using technical indicators to enter the market is one of the most used scalping strategies using technical indicators to enter the market. One advantage of scalping in stock trading is that the risk is lower than for futures. However, there’s no leverage to multiply your profits either. Scalpers have an opportunity to choose from a wide range of stocks exhibiting different levels of volatility. They can go for strategies involving bid-ask spread or price action. Unlike the forex market, price movements can be unpredictable depending on the idiosyncrasies of the stock. Setting a target tick value for closing out a trade may not work out in a scalping strategy for equities if stock movements are unfavorable and exhibit any trend towards circuit breakers. 

Irrespective of the type of asset involved, establishing a stop-loss is critical for a scalping strategy to work. One loss could erode the cumulative profits obtained from multiple trades.

Final Thoughts

Scalping can be an effective way to succeed in trading. However, it also comes at great risk and requires considerable experience and effort. It can be an alternate source of income for people well-versed in trading. The scope of scalping is tremendous and can be used in different asset classes depending on the experience of a trader. With improvements in trading systems, one could only see scalping gain popularity in the future. It also allows for market efficiency by eliminating any arbitrage possible through bid-ask spreads.

F.A.Q

The post What is Scalping Stocks? – How to Use Scalping Trading Strategies appeared first on Earn2Trade Blog.

The Underlying Mechanics of Futures Trading

Futures are derivatives that give the buyer the right to buy an underlying asset at a predetermined price and an agreed-upon future date. The underlying asset can be commodities (corn, oil, soybeans) or financial instruments (foreign exchange, stocks). Buying a futures contract is what we call going long. Meanwhile, selling one (or borrowing it to sell) is going short. Let’s look at a simple example that will help us understand the dynamics of futures contract expiration.

Consider Trader A to going long on a futures contract covering 100 shares of XYZ assets with a future price of $100, and the contract is set to expire after 90 days. If Trader B sells this contract to A, he has taken a short position in the futures contract. After 90 days, if the price of XYZ is $105, it will be beneficial to Trader A since he can buy the shares at $100, the future price at the start of the contract. Trader A can pay $100*100 or $10,000 and take delivery of 100 shares of XYZ.

Alternatively, Trader B can settle the contract by paying the differential amount to Trader A without delivering the shares. The amount that Trader B needs to pay or the loss he incurs is 100*$(105 – 100) or $500. If on the expiration date, the price had been $95, then Trader B would have made a profit of 100*$(100 – 95) or $500.

In the above example, the contract was between two parties, settling on the expiration date. In reality, traders have the option to offload the position in these contracts even before the expiration date. 

Why Do Futures Contracts Expire?

Futures contracts have an expiry date, i.e., the time by which the contract needs to be settled. The counterparties entering a contract may have different requirements or expectations while setting up an expiration date. For example, if a farmer expects to harvest wheat in 90 days and wants to lock in a price, he can enter a contract that allows him to sell wheat at a fixed price in 90 days. Similarly, if someone expects the price to increase in 90 days, would buy the contract that would enable him to buy at that predetermined price.

A definite expiration date ensures that futures contracts are standardized. 

Contract Expiration Options

As discussed earlier, there are many ways a trader can take close out the contract. By closing out a contract, one could imply either of the two:

1. Take an offsetting position
2. Settle the contract

In the first case, the trader enters into a new contract opposite to the current position. In the second option, the futures contract is settled, and the position is closed out. Traders can also continue to take exposure in the contract by rolling it over to a future date.

The flexibility that a futures contract offers is one of the primary reasons many prefer these over forwards. A deeper market enables traders to indirectly settle a position much before the expiry date. The quicker turnaround in offloading an open position mitigates the risk. This risk reduction mainly matters when the prices do not move in favor of the trader. The section below will examine the ways to close out a position. 

1. Offset the Position

An offset position involves taking an opposite position to the one that the trader is currently exposed to. If the trader is not holding a long position, then the offset position is to go short on a similar futures position. Any loss incurred in the original position is expected to be nullified by a profit in the offset taken. This is the most common way of exiting a trade, and it also ensures that the trader does not have to take physical delivery of the underlying asset. 

Rollover

Rollover is another function traders use to maintain their position as the contract approaches its expiry date. For the rollover to occur, the current contract needs to be offset (see the previous section on offsetting a position), and the trader simultaneously seeks a new contract at a forward date.  Rollover is actually a way of extending a contract rather than terminating an existing one. For a rollover to occur, traders need to monitor the volume of the existing contract and the contract that expires at a date later than the actual future date.

For example, consider a trader who has bought four futures contracts on the S&P 500 expiring in July. If he wants to roll over these contracts to September, he would need to short four futures contracts on the same index and simultaneously buy four contracts on the same underlying that is expiring in September. Similar to placing an offsetting position, the trader does not need to take delivery of the asset during a rollover.

2. Settlement

Settling a futures contract involves terminating the contract by clearing the payments arising out of the position held. Unlike offsetting or rolling over, the settlement is done on the expiry date. The settlement of futures contracts can be done through physical settlement or cash settlement. The major drawback of a settlement is that the trader must wait until the expiration trade to close out the position. Since futures contracts provide the flexibility to roll over or offset before the expiration date, traders generally do not prefer to wait till the expiration date. The risk is particularly high for someone who is short in the contract because hypothetically, the trader is exposed to unlimited liability if the underlying asset price keeps on rising (refer to the example on the mechanism of futures trading).

Physical Settlement

This involves the actual exchange of the asset in return for the price that was agreed upon as a part of the futures contract. The contract buyer is obligated to purchase the asset, while the seller is responsible for storing/maintaining the asset and delivering it on the expiration date. For physical commodities (like oil, wheat), the exchange establishes a standard for the underlying good. Physical commodities also need to be stored in specific warehouses, and the buyer has the option to take them out of the warehouse or keep them by paying a storage fee. The storage fee and handling/shipment costs constitute the major drawbacks associated with physical settlement. Unless the buyer really needs the asset, it would not be prudent to opt for a physical settlement. 

Cash Settlement

It is easier to settle the futures contract by cash instead of going for a physical settlement. The trader just needs to pay the differential amount if he incurs a loss or receives a sum if the contract is profitable. Suppose a trader enters into a long futures contract to purchase crude oil at $75. If the spot price on the expiration date is $80, the trader will receive $5 per barrel as cash settlement. This would translate to a profit of $1,000*5 or $5,000 (since each contract comprises 1,000 barrels of oil). Compared to taking delivery of 1,000 barrels of oil, settling the contract in cash is definitely more convenient in this case. The trader can also take a similar approach for contracts involving financial instruments like stocks.

What’s The Impact of Expiration on Liquidity and Volume?

As the expiry date approaches, there could be a rise in price volatility as traders look to take advantage of any imbalances arising out of the future price and the expected spot price. If a trader is long a stock, he may short futures on the same stock and benefit from the two positions’ price difference. Now, just before the expiry date, the trader could look to square off the short futures position to minimize his loss by going long directly on the stock. This increases the volume traded for the stock and increases the liquidity in the counter. Sometimes it may so happen that the trading volume is low on account of severe macroeconomic developments. This scenario is something we frequently see in crude oil futures. In such a scenario, liquidity can be a constraint leading to high losses for traders.

How to Find the Expiry Date of a Futures Contract

Futures contracts have a specific date on which the contract expires. By specific date, it implies that exchange generally fixes the day of the month when the contract should expire. Typically, it happens on the third Friday of the expiration month. This day can vary across different markets and products. An example of futures contract expiration is shown below.

The above illustration represents corn futures, and the month and year mentioned is the expiration time. The representation is similar for futures in other categories like equity indices (S&P 500) or other treasury products. Traders should also know the day the contracts expire for each type of contract and trade accordingly.

Conclusion

A trader’s actions before or on the expiration date can be critical in determining how profitable the trade would turn out to be. Traders can use the numerous options available to either minimize the loss or even generate arbitrage profits. The expiration date on futures contracts has been gaining traction, and this is evident from the increased volatility and trading volume as the expiry date approaches. 

The post What Happens If You Hold a Futures Contract Until Expiration? appeared first on Earn2Trade Blog.

What are the 52-Week High and Low?

One can often interpret the 52-week high and low as the maximum and minimum price level that a particular stock reached this past year. However, this is not the case. We also need to consider the closing price to determine the 52-week high and low. 

Let’s illustrate with an example. Suppose during a trading session, the price peaked at $100, but at the end of the day, it dropped to $98.5. To determine the high or low, one would only consider the closing price. In this case, the $100 peak price is irrelevant. To simplify, we can express the 52-week high and low mathematically with the following formula:

52-week high = maximum (P₁, P₂……………………P_n)

P represents the closing price of each trading session.

Likewise, the 52-week low = minimum (P₁, P₂……………………P_n)

The Importance of The 52-Week High and Low

The 52-week high and low can be useful for several trading strategies. For example, when the price manages to rise above the 52-week high, then it might signal a breakout, prompting the traders to buy. Similarly, if the price falls below the 52-week low, it could indicate an opportunity to sell. 

For stocks with a history of low volatility, the 52-week high can act as a resistance level, and the 52-week low can be a support. Traders can use the 52-week range to predict the movement in price and act accordingly.

An Example

The chart below shows the 52-week price of Amazon shares. In the initial stage, there was an uptrend. However, since July, the price has been range-bound.

The arrow at the top represents the high, while the arrow at the bottom represents the low. Now we can see that there have been multiple instances when the price appears to exceed the high. However, afterward, this level acted as a resistance. We can see how there was a fall in price every time the line was tested.

Similarly, the price indicated by the lower arrow acted as a support, and this prevented the stock price from dipping further. 

It may so happen that the stock price exceeds the one represented by the 52-week high in the future. This would give an indication to the traders that a breakout is possible. 

How to Find the 52-Week Highs and Lows

The procedure to determine the high and low for a 52-week period is fairly straightforward. You can find out the following steps to determine what you want to know:

1. Find the stock using the symbol or name.
2. Look into the summary section for the 52-week high and low. In many cases, the 52-week range is provided in the summary section.
3. If the range is not provided, ensure that the price chart shown is for a 52-week period. Hover the cursor on the topmost point of the chart. This should represent the 52-week high. Similarly, the lowest point would be the 52-week low.

The method provided in Step 3 can be less accurate if the actual peak is not discernible by looking at the chart. One can also download the closing price for the period and apply the mathematical equation discussed earlier. 

Risks of Trading Based on The 52-Week High and Low

Like every technical indicator, the high and low level does not guarantee how the stock price would behave. We can point to two example cases when the movement is in contradiction to our expectations.

Case 1: An asset in a consolidation phase

When the price is trading in a range-bound manner, one would expect the 52-week high to be the resistance level and the low as the support. Suppose the price is trading very close to the low. In that case, we expect the price to increase, giving the trader a buy signal. If the trader executes a long position and the price drops further, they suffer a loss. Instead of trading range-bound, there could be a breakout, with the share price falling rapidly. 

Case 2: An asset in a breakout phase

As mentioned earlier, if the price exceeds the 52-week high, it would indicate a breakout in the stock price. If a trader follows this cue, he is expected to buy when the price is over the 52-week high and sell when it is lower than the 52-week low. But, again, the trend may not necessarily continue the way we expect it to. You could see a reversal from the breakout. Traders generally wait for the price to move further away (higher from a 52-week high or lower from a 52-week low) before taking on a position. This ensures that the possibility of a breakout is higher. 

In the two cases above, following patterns based on the range can lead to a loss for the trader. One way to minimize this loss is to maintain a stop-loss order. 

52-Week High and Low Reversals

When the stock price trades close to its 52-week high, traders expect the price to trade lower in the future. As a result, many are willing to sacrifice the potential for future profit because they believe that the scope for appreciation in price is limited. This applies to a 52-week low, where traders expect this to be a support level and expect it to rise. 

Reversals can be an effective intraday strategy. If the price manages to touch the high or low during the trading session, traders can reasonably expect the trend to reverse. Professional traders should leverage this information along with other technical indicators as well as trade volume metrics. We can use additional technical indicators to predict reversal patterns, including the descending wedge or the rounding bottom. When you see these patterns close to the maximum or minimum price over a 52-week period, traders should expect a reversal. 

If the reversal does not occur, a stop-loss order should be put in place to minimize the loss. However, as stated earlier, many traders prefer to play the wait and watch and only enter once the reversal in trend becomes apparent. 

Examples of a 52-Week High and Low

52-week high: This can act as a resistance level and a starting point for a breakout. Through the charts, it can be seen how both the scenarios can be witnessed.

The chart above shows a strong uptrend as soon as the price crosses the maximum price. This is because the chart comprises closing prices over 18 months, and the breakout occurs when the price action manages to breach the resistance level.

It can so happen that instead of continuing with the momentum, there is a reversal when the stock is trading close to its 52-week high. The same can be illustrated in the example below:

52-week low: Again, the same trends, i.e., breakout or reversal, can also be observed when the price is close to the 52-week low. 

The figure above shows that the 52-week low can act as a support for some time. However, we saw a strong downtrend when the price crossed this level.

When the 52-week low acts as a support level, we can observe an upwards price reversal. In the previous example, we saw several such reversals before the price started dropping sharply. It is generally the case wherein the support level is tested multiple times before the downtrend develops. This can be considered in case of a resistance level too. 

The patterns we observe around the 52-week range can be beneficial for day traders. Not only scalpers but also swing traders can generate profitable trades from these trends. 

Conclusion

The 52-week range may be simple information, but many traders find it immensely helpful. It can be a useful tool, especially for someone new to trading and looking for a simple approach. Even expert traders often use it for their trading activities. It is also a measure of value that tells us how to place the stock compared to data sets within the year. Many analysts tend to base their predictions on how the price fares compared to the 52-week high or low. The range is also a good indicator of how volatile the stock is and whether it’s too risky to trade. 

The post The Importance of the 52-Week High And Low – A Complete Guide appeared first on Earn2Trade Blog.

Introduction

The article will elaborate on the Supertrend indicator and how to calculate it. It also focuses on the configuration and interpretation of the indicator. We will also go through a real example to demonstrate how you can use the Supertrend indicator to empower your trading decisions.

What is the Supertrend Indicator?

The Supertrend indicator is a technical analysis tool that helps identify strong upward and downward trends. The indicator uses previous prices as input and compares the current price with the indicator’s line to determine the future price trajectory. The Supertrend indicator is beneficial in trending markets but may be an unreliable measure during periods of consolidation. Traders often use it alongside other technical indicators like the Exponential Moving Average (EMA).

How to Calculate the Supertrend Indicator

The Supertrend indicator consists of just two parameters – the time frame and the multiplier. The default setting is usually 10 days and 3, respectively. Since the indicator may be used for placing intraday trades, one can adjust the time frame to a few minutes. A shorter duration is especially appropriate for traders looking to profit from small price movements. Traders having a long-term view might set the time frame to a few days or even weeks. 

Calculation

Now we need to construct two lines – an upper and a lower one. You can see the mathematical expression for each line below:

Upper Band = (High Price + Low Price)/2 + multiplier * Average True Range

Lower Band = (High Price + Low Price)/2 – multiplier * Average True Range

Average True Range = (Average True Range for n-1 periods * (n-1) + Current True Range)/n

The two inputs in the above equations are n (time period) and multiplier.

Another vital element in the calculation is the True Range. A normal range is simply the difference between the intraday high and low. On the other hand, the True Range accounts for the closing price for the previous day. 

The calculation for True Range is as follows:

True Range = max (High – Low, |Close – High|, |Close – Low|)

Close refers to the closing price of the previous day.

|Close – High| and |Close – Low| measure the absolute value and is a positive number.

The True Range is a better way to account for the volatility in price because sometimes the market may trade above the previous day’s close or below the previous day’s high. Calculating the range without considering the last closing price would lead to a lower volatility figure. For example, if the previous closing price was $100 and the high and low for the day were $110 and $105, respectively. The range would be $5 ($110 – $105). 

True Range = max (110-105, |100-110|, |100-105|) or $10, which is $5 higher than the range.

Setting up the Supertrend Indicator

It is straightforward to set up a Supertrend indicator on the chart. Since it uses the same scale as the price chart, the Up and Down bands are superimposed on the same chart. The following figure shows the default setting for a Supertrend indicator.

The timeframe refers to how the chart has been constructed. The price data could be shown for a few minutes for intraday charts. The equivalent ATR length based on the above default setting would be 10 minutes, and the factor or multiplier would be 3.

If the price is shown daily (as illustrated in the chart below), the ATR length would be ten days.

A trader must configure the chart settings and input the Average True Range and factor according to the trading strategy.

Using the Supertrend Indicator

Once the Supertrend indicator calculation’s parameters are handled, the charts will display the Supertrend indicator as a line. The green line refers to the Upper Band, and the red line is the Lower Band. One can observe that these lines are not continuous, i.e., the Supertrend line is a combination of Upper and Lower bands. The Upper Band line is the Supertrend line below the candlesticks. Similarly, red lines form the Supertrend indicator above the candlesticks.

One can analyze how the Supertrend indicator changes color to determine whether there is a buying or a selling opportunity. There are several instances in the chart above where the line has given such signals. It is always good to add other technical indicators along with the Supertrend indicator to enhance its predictive power.  

Supertrend Indicator Trading Strategies

A trader can look at the line and determine if the asset needs to be bought or sold. A green line allows buying, whereas a red line suggests selling. Looking at the chart above, we can see that when the Supertrend line shifts from red to green, there is a strong trend upwards. When the line turns red, the price drops. 

You can use the Relative Strength Index as an additional tool to validate the signals from the Supertrend Indicator. Here is an example of the combination:

You can see two marked areas – one in red and the other in green. In the red area, you can see that the Supertrend turns red from green. The RSI is also above 74, another signal for a price drop. In the subsequent few sessions, we see that the price goes down. Similarly, in the green segment, the Supertrend turns green from red. The RSI is also close to 25, which is a clear buying signal.

The above is a simple illustration of how we can use other technical indicators along with the Supertrend line. There may likely be occasions during which signals from different indicators may contradict each other. It is advisable to use the indicator only when multiple indicators validate the same outcome. You can also use the Supertrend indicator to identify stop-loss levels. Along with the RSI, other technical indicators commonly used with the Supertrend are the EMA and MACD.

Advantages and Disadvantages of the Supertrend Indicator

Advantages of the Supertrend Indicator include:

1. Easy to interpret: The calculation isn’t very complex even for beginners.
2. The predictions are fairly accurate: This is especially true during trending markets where the Supertrend is among the most reliable indicators available.
3. Easy to configure: Since the number of input variables is lower, it can be easily adjusted to meet the trader’s requirements.
4. No cost involved: It is available on many free platforms, and additional software or add-ins are not required to implement the indicator.
5. Highly responsive: It is quick to detect a change in trend, making it very handy for traders looking to exploit opportunities as soon as they arrive.

The common disadvantages of using it are:

1. Not accurate during consolidation periods: When the market is trending sideways, the Supertrend line may generate false signals.
2. The outcome may contradict other tools: It may yield contrasting results that may not help your trading decisions. 
3. May not work well with all assets: Traders must ensure that the indicator is reliable in the specific asset before using it. While the signal may be strong, it may not apply to all assets.

The post The Supertrend Indicator – Definition and Application appeared first on Earn2Trade Blog.

What is the Commodity Futures Trading Commission (CFTC)?

The Commodity Futures Trading Commission (CFTC) is an independent body responsible for regulating the futures and options market in the United States. Any firm or person looking to participate in the commodity futures market needs to register with them. The agency looks to promote futures trading in the US and improve competitiveness and efficiency. They do so by ensuring a level playing field for all investors. The CFTC also monitors the commodities trading market for unfair practices like fraud, market manipulation, and other illegal activities. With the evolution of technology, the supervisory activity of the CFTC has become more complicated. Today trades happen at a much faster pace, opening up opportunities for potential exploits.

The scope of the CFTC has also expanded over the years. Now it covers different aspects of the commodities derivatives market. The CFTC also oversees other participants in the futures market like brokers, commodity trading advisors, and commodity pool operators. This makes their task all the more challenging. The agency also needs to monitor the activities of stakeholders outside the marketplace. For example, a commodity trading advisor who oversees a managed futures account may adopt a strategy that may not be in their client’s best interests. The CFTC also has the authority to look into the activities of asset managers and intervene if their practices are not in line with the best interests of their clients. 

How is it organized?

The CFTC consists of 5 commissioners appointed by the President of the United States. One among these serves as the Chairman of the Committee. These positions are held for a tenure of 5 years, and they do not become vacant at the same time. There are also 13 divisions and offices within the CFTC. You’ll find the full list below in no particular order.

• Clearing and Risk (DCR): DCR stands for Division of Clearing and Risk. This division is responsible for supervising the participants involved in the clearing process. Some of the clearing agents include swap dealers and futures commission merchants.
• Enforcement (DOE): As the name suggests, the Department of Enforcement is responsible for investigating any alleged violation and proceeding with punitive measures as well.
• Market Oversight (DMO): This division ensures that the markets are fair, transparent, and competitive by overseeing all the trading platforms. It also reviews any new applications and assesses whether the potential participant adheres to regulatory requirements and system standards.
• Market Participants Division (MPD): This division looks into the activities of intermediaries in the derivatives market, namely commodity trading advisors, futures commission merchants, and commodity pool operators. Through its Office of Customer Education, the MPD develops educational material to support customers and prevent them from violating any rules or being victims of fraud.
• Division of Data (DOD): This division is responsible for managing the data of CFTC via support analytics and other strategic initiatives.
• Legal Division (LD): This division supports all of the agency’s legal functions. This includes providing legal advice and representing the CFTC in various litigations. 
• Division of Administration (DA): The DA manages internal functions like finance, security, and operations. 
• Office of the Chief Economist (OCE): This office is primarily for the conduction of research. It provides economic advice on the implementation of any new regulation. It is also responsible for training staff.
• Office of International Affairs (OIA): This is the face of the CFTC in international forums. It looks into international regulatory frameworks. 
• Office of Public Affairs (OPA): This body is essentially the public face of CFTC on the domestic front. It provides information to the public to build trust and to communicate with different stakeholders.
• LabCFTC: As trading platforms become more sophisticated, LabCFTC promotes innovation and ensures that the public knows any new innovation.
• Office of Legislative and Intergovernmental Affairs (OLIA): This office acts as a bridge between the CFTC, Congress, and federal agencies. The OLIA helps in developing legislation on behalf of the CFTC.
• Office of Minority and Women Inclusion (OMWI): The OMWI promotes equal opportunity and diversity at the workplace. This department also handles any issues related to civil rights.

The CFTC also has three regional offices in Chicago, Kansas City, and New York.

The History of the CFTC

When futures contracts were first developed in places like Chicago, Kansas City, and New York during the late 1800s, the commodity futures market was still fragmented. It was only during the 1970s that the scope of futures contracts increased. Futures contracts on foreign currencies, Treasury instruments, and stocks became popular during this time. 

The CFTC came into existence after the Commodity Futures Trading Commission Act of 1974. This act replaced the Commodity Exchange Act of 1936. The original 1936 act had already undergone several changes before the CFTC Act passed. The primary objective of the Commodity Futures Trading Commission Act was to establish an independent agency that could oversee the commodity futures market. This gave the agency more authority to regulate the commodity futures market.

The CFTC has come a long way since the Grain Futures Act of 1922 was penned to oversee agricultural products. The number of commodities increased considerably, but there is also a wide range of other assets that the CFTC has to monitor. The agency has also been taking an active role in regulating futures related to cryptocurrencies like Bitcoin.

What does the CFTC do?

The way the CFTC is structured should give a broad indication of its major functions. With time, the scope of what the CFTC does has expanded. You’ll find a comprehensive list of what the CFTC does below:

• Overseeing the commodity futures market activities: The CFTC ensures that unfair practices are not employed, and the market is transparent and fair.
• Creating regulations: The legislative wing assists Congress in framing regulations governing the market it regulates. The chief economist carries out the assessment of such legislations.
• Prosecuting participants who do not adhere to the rules: In addition to overseeing, the CFTC also engages in prosecuting participates in fraud, market manipulation, and other illegal activities
• Protecting customers’ interest: The CFTC achieves this by keeping an eye on advisors and asset managers responsible for acting in the best interests of their clients. The commodity futures market can be a risky space to venture into, and there are times when intermediaries do not act in the best interest of their customers. The CFTC can look into the activities of these intermediaries so that customers are not deceived. The CFTC only allows credible market participants so that investors do not have to worry about losing their money.
• Engaging with external bodies: As friction among markets worldwide eases, it becomes essential to understand how other markets operate. The CFTC engages with local bodies like the FRB and is also involved in consultations with other international bodies.
• Educating the customers: There have been numerous instances in which clients have become victims of fraud and other inappropriate activities. In most cases, these people were not aware of the products that they had invested in. The CFTC updates and provides educational content so that investors do not lose wealth because of unscrupulous agents.
• Pioneering digital initiatives: The transition from a physical platform to an online platform has made it easy for market participants. One can expect that in some time, all commodity futures contracts would be settled online. The CFTC has constantly been trying to develop strategic changes that make the trading of futures smoother. A robust digital platform also ensures better governance and improved risk management capabilities.
• Providing ancillary services: These could include data analytics and other consultation papers that can provide insights into the commodity futures market. The CFTC has also been proactive in bringing digital assets like Bitcoin under its jurisdiction and categorizing it as a commodity.

What does the CFTC regulate?

The Commodities Exchange Act is still the regulatory framework governing commodity futures in the United States. The list of participants the CFTC regulates includes the following:

• Trading Organizations: These include Designated Contract Markets (DCM) and Swap Execution Facilities (SEF). DCMs are essentially exchanges that list commodity futures and options and allow traders to participate. SEFs cater to the swap market. The CFTC reviews each DCM and SEF regularly to establish compliance with all the rules and regulations.
• Clearing Organizations: The Derivatives Clearing Organization (DCO) must comply with the core principles of the CEA, which states that the DCO should be adequate in terms of operational and financial resources. The DCO should have robust risk management systems and have efficient rules to deal with default.
• Data Repositories: The facility to store data is given to SDRs or Swap Data Repositories. The data includes storage of trades both cleared as well as uncleared.
• Intermediaries: The CFTC regulates a wide array of intermediaries. These intermediaries act as agents for other people when dealing with futures, swaps, and options. The intermediaries coming under the purview of CFTC are:
  • Commodity Pool Operator (CPO): Commodity pools are funds that trade in commodities. The CPO acts as an agent that helps raise funds.
  • Commodity Trading Advisor (CTA): Funds or individuals hire them to provide advice on commodity futures, options, or swaps.
  • Futures Commission Merchant (FCM): FCMs accept the order to purchase or sell any commodity for future delivery.
  • Introducing Broker (IB): An Introducing Broker places an order on behalf of a client 
  • Major Swap Participant (MSP): MSP is not a swap dealer but an agent who holds a significant position in any major swap category.
  • Swap Dealer (SD): Acts as a dealer or market maker for swaps. SDs could also directly enter swaps as the normal course of their business.

In addition to the nature of market participants in the commodity futures space, the CFTC can also determine which commodities you can trade via futures. There was a time when the commodity futures market only consisted of a few assets. Nowadays, US exchanges even offer foreign products. The CFTC has also been responsible for regulating futures on cryptocurrencies. Over time, the CFTC has expanded. The number of products that it managed has also increased at a very rapid rate. 

How does the CFTC affect Futures Trading?

The CFTC affects the futures trading business in multiple ways. As a regulator, it ensures that the market is a level playing field for all the participants. It ensures enough liquidity and keeps on upgrading the list of products offered based on what the economy needs. The CFTC has led the digitalization of trades. Today trading mainly happens through online channels, and their contributions are undeniable. The open outcry channels that once used to dominate the market have become outdated. Trading pits are so rare they’re almost non-existent.

The CFTC also plays a critical role in expanding the commodities futures market by drawing the interest of foreign investors. It’s not a surprise that the commodity futures market in the US is the most active. The underlying assets for the futures they offer can be very diverse. The volume has also increased, and the execution time and efficiency of trading platforms have improved considerably. 

The CFTC also keeps a check on fraudulent activities. They do so via risk management systems that keep tabs on the activities of traders. It also ensures that anyone looking to obtain a license should have adequate technology in place. By collaborating with international regulators, the CFTC has also helped reduce the friction existing between markets. There has been an influx of foreign investors in the US market due to this, making the market more liquid. 

How does the CFTC enforce its rules?

The CFTC acts as an independent agency responsible for regulating the commodity futures market in the United States. While the onus of framing legislation lies with Congress, the CFTC plays an active role in providing advisory support. Laws concerning commodity futures rarely pass without involving the CFTC in the discussion.

The CFTC can also cancel the registration of participants who fail to comply with the regulations specified in the acts that govern commodity futures trading. It also has the discretion not to approve the application of a market participant if it deems them to be unfit. Furthermore, the CFTC can initiate legal proceedings against those who break the rules and engage in unfair practices like market manipulation, fraud, terrorist financing, etc. The agency imposes hefty fines on bad actors who use illegal means to profit from futures trading. 

Final Thoughts

The CFTC has assumed a major role in the development of the commodity futures market. It is a key factor in ensuring that commodity trading will continue to thrive in the future. As an independent regulator, the CFTC has shown how effective a dedicated regulator can be at meeting the requirements of specific markets. Soon, all eyes will be on how the CFTC handles the digital asset space and whether it can manage to further develop this market.

There is a lot of development in the fintech space as well. That’s why the CFTC has a dedicated office to look into this sector. It would be interesting to see how the agency incorporates advanced computing techniques like big data and artificial intelligence in the commodity futures market. Such innovations can assist the regulator in maintaining oversight of the trading activities and detecting any fraudulent activities immediately. It will also improve their analytics capabilities. 

The CFTC also faces pressure from other global markets looking to grab a greater share of the international futures market that US exchanges dominate. Whether it can manage to maintain the status quo of US hegemony in the futures market remains to be seen. For further reference, you can check out their official site here.

The post What Does the CFTC Do? More on The Futures Trading Commission appeared first on Earn2Trade Blog.

The Arms Index Formula and Calculation

The formula for the Arms index (TRIN) is as follows:

TRIN = (Advancing Stocks/Declining Stocks) / (Advancing Volume / Declining Volume)

• Advancing Stocks = Number of stocks higher for the day
• Declining Stocks = Number of stocks lower for the day
• Advancing Volume = Total volume of advancing stocks​  
• Declining Volume = Total volume of declining stocks

Although most technical charts already include the TRIN indicator, it can also be calculated step by step like so:   

1. Choose your set intervals. They can be every five minutes, every hour, daily intervals, etc.…
2. Divide the number of advancing stocks by the number of declining stocks to calculate the AD Ratio.
3. Next, divide the total advancing volume by the total declining volume to get the AD Volume.
4. Then divide the AD Ratio by AD Volume.
5. Record the result and plot it on a chart.
6. Repeat the same steps at the next interval.  
7. Connect the data points to form a chart and see how the TRIN trends over time.

You might also enjoy:

• Commodity Channel Index (CCI) – How to Use The CCI Indicator
• Bull Trap – Using Point and Figure Charts to Avoid False Signals

What Does the Arms Index Tell You?

By analyzing both the strength and breadth of stock movements, the Arms index provides investors with a real-time explanation of market indexes’ overall movements. 

A value of 1.0, for example, indicates that the market is in a neutral state. Why? Because a value of 1.0 means that the AD Ratio is equal to the AD Volume and that up volume is evenly distributed over advancing stocks. In contrast, down volume is evenly distributed over declining stocks.

The TRIN indicator provides a bullish signal when it is less than 1.0. When it is greater than 1.0, then it’s a bearish signal. Alternatively, when it is less than 1.0, there is a greater volume in the average up stock than the average down the stock. When the level is greater than 1.0, there is a greater volume in the average down stock than the average up stock. The further from 1.0 that the TRIN indicator’s value is, the greater the contrast between buying and selling on that day or interval. A strong up day, for example, will push the TRIN down. Meanwhile, a strong down day will push the TRIN up.

How Does TRIN Work?

The TRIN is a breadth oscillator that helps measure internal market strength or weakness. It is a short-term technical trading tool that measures volatility in the stock market and represents the relationship between advancing and declining stocks and their volume. If the TRIN is trending upwards, that means the market is weaker: Conversely, if it is trending downwards, that means the market is stronger. The TRIN often moves inversely to the index being analyzed. When it spikes higher, sell-offs usually occur. When the TRIN drops sharply, rallies usually occur. 

Often the moving average of the index is included as well when evaluating the TRIN. By analyzing the moving average, the data can be smoothed out while giving investors a better understanding of whether the trend is up or down. The moving average also aids in identifying support or resistance areas.

Finding Overbought and Oversold Levels with TRIN

Because the TRIN is a breadth indicator, finding overbought and oversold levels in major indexes is one of its main goals. While we already mentioned that 1.0 is the neutral value and that the TRIN moves inversely to an analyzed index, very high or low readings in the indicator may signal that levels are either overbought or oversold and due reversal. While overbought and oversold levels may vary slightly by index, the TRIN can always tip us off. When the value of the indicator dips below 0.50, that may indicate overheating and an overbought market.  When the indicator’s value exceeds 3.00, that may indicate an oversold market and with an over-extreme bearish sentiment. While the TRIN indicator isn’t always correct, it is a valuable resource when tipping off investors before a dramatic price shift or reversal.  

How to Trade Using the TRIN Indicator (with Examples)

The TRIN indicator is particularly beneficial when day trading or swing trading. Traders look at the value of the indicator and how it changes throughout the day. They also look for extremes in the index value and are always looking for signs that the market may soon reverse.

Example 1

When using the TRIN indicator, it is best to combine it with other indicators. Examples of such can include the moving average or Bollinger Bands to help avoid miscalculations and false signals.  

The example above shows the S&P 500 in an upward trend for one year. As the S&P was trending upwards, the TRIN indicator was below 1.0, further confirmed by the double exponential moving averages.

Example 2

The below chart is another example of how to trade with the TRIN indicator. This chart compares it with key turning points in the Nasdaq.

By using the TRIN and focusing on the Nasdaq’s price movements, we can make several observations. If we utilized the TRIN and were trading the NASDAQ at this time, we could make several strategic moves as well. 

When the TRIN is above 1.0 yet below 2.0, it signals that stocks are under pressure and a short-term decline is near. In this example, there are three instances where the TRIN spiked and signaled a short-term correction in prices. The candlesticks marked by the red arrow show the resulting price action after the TRIN spiked on the chart.

In the first instance, there was a morning star type of candlestick pattern. Next, in the second instance, there was a harami-like candlestick pattern. It shows support from the 50 and 200 period moving averages. Finally, in the third instance, there was a subsequent bullish reversal candlestick pattern. This happened after the TRIN spiked and indicated a decline.

While these patterns each have differences, there is a general three-step trend here.

• Step 1: TRIN signals a correction by spiking. Price falls accordingly
• Step 2: Price confirms a reversal, and is further validated by its volume. 
• Step 3: Price exceeds the previous high 

Example 3

Let’s take another look at the TRIN indicator when trying to detect extreme readings with Apple’s stock.

This is an example of how we can use extreme TRIN readings to predict sharp price reversals. In this example, with Apple’s stock, when the TRIN posted an extreme reading above 1.75 and below 0.5, a sharp price reversal occurred. Large-cap stocks such as Apple usually respond the most to shifts in the indicator.

Another great way to trade with the TRIN indicator is to use Bollinger Bands. By using it alongside Bollinger Bands, traders can strategically decide what moves to make depending on when the TRIN spikes and tests the upper or lower band limits. Bollinger Bands are popular technical tools consisting of a band of three lines plotted relative to security prices. The middle line is usually the 20-day moving average and serves as the upper and lower bands base. The upper and lower bands are usually set to two standard deviations away from the moving average. They are used as a way to measure volatility by observing the correlation between the bands and price. Using the TRIN indicator with Bollinger Bands could look something like this:

When used with Bollinger Bands, the TRIN indicator can be especially useful as a guide for investors when trading during spikes of volatility 

Advantages of The TRIN Indicator

There are several advantages of using this indicator. Some of these advantages include the following:

• When dissecting the TRIN calculation, it gives traders a deeper insight into market performance and trends by examining which assets are advancing and which ones are declining.
• The TRIN compares net advances to volume. While most traders only pay attention to price movement, volume truly plays just as important of a role. Price movements that correlate with high volume hold more significance than price movements that correlate with low volume. Why? Low volume usually does not cause a significant price shift, while high volume implies a significant shift. 
• It provides traders with a clearer picture of what is truly going in an index.
• The TRIN is a good indicator and predictor of stock movements. With the TRIN’s formula, its values serve as buy, sell, and hold signals. These values tip off traders on which way a stock or index could trend. 

Disadvantages of The TRIN Indicator

While the TRIN indicator has several advantages as a helpful tool, there are also significant limitations and disadvantages. 

• The TRIN is always prone to inaccurate results because of the emphasis it places on volume. For example, if there’s an instance when there are twice as many advancing stocks as declining stocks and twice as much advancing volume as declining volume, it would yield only 1.0, meaning a neutral signal. Additionally, say there were three times as many advancing stocks as declining stocks and twice as much advancing volume as declining volume. Despite the bullish day, the TRIN would yield 1.5= a sell signal! These instances are clear examples of how the TRIN can be very misleading and unreliable. 
• Elaborating on the previous point, the TRIN is not always reliable as a standalone technical measurement. Traders use moving averages or Bollinger Bands in association with the TRIN, for example, to double-check the indicators’ data and reliability. 

Final Thoughts

Nobody can predict the future with complete certainty. If they could, everyone would invest in the stock market. But using the Arms Index indicator can help investors make sense of price movements as they relate to volume. This helps them make more practical decisions based on the breadth and depth of these movements. Trading in the stock market will always involve risk. Day trading involves even more risk. However, understanding the TRIN indicator, reading it, and analyzing it in collaboration with other measurements, can be a useful tool for aiding traders to reach their financial goals. 

The post Arms Index (TRIN) – What is the Short-Term Trading Index? appeared first on Earn2Trade Blog.

What is the Average True Range?

To understand what ATR is, one must first get familiar with the difference between range and True Range. The range calculation takes into account only the prices during a particular period. In simple terms, the range is the difference between the high and the low for a given period. 

The calculation for the Range can suppress the volatility measure if the intra-period volatility is low, but there is a substantial price movement within different periods. Here is an example – suppose yesterday’s closing price was $50. When the market opened, the price jumped to $60. If the intraday price remains above $60, the calculation of the range won’t take into account the jump from $50 to $60. 

For such deviations, the True Range comes in handy. Think of it as a more refined version of the range. While the range requires the high and the low for the day, the True Range also takes into account the previous closing price as an input.

True Range Formula

The formula for the True Range is:

True Range = max (High – Low), abs (High – Close₁), abs (Close₁ – Low)

where:

High and Low refer to the current bar

Close₁ is the close of a previous bar

Suppose the previous close is $50, and the high and low prices are $60 and $55, respectively. In that case, the calculation is as follows:

True Range = max (60 – 55, 60 – 50, 55 – 50) or $20

On the other hand, the range is only $5 ($60 – $55), and this figure clearly underestimates the volatility. Therefore, the range is not appropriate when the intraday prices are above or below the previous closing price. In the example, a True Range is a more appropriate measure of volatility since it doesn’t suppress the impact of the last closing price on the calculation of the range even when the price has continued to trend upward during the day.

ATR is simply the average value of all the true ranges for a given period. For n periods, the ATR is calculated as:

ATR = 1/n * sum (TR₁ + TR₂ + ……….+TR_n)

Where TR is the True Range for each period.

How to Calculate the ATR

The formula above gives the exact value of ATR. It requires the exact True Range figures for each preceding period. There is also an approximation method that takes into account the ATR of the previous period alongside the current True Range. Based on the approximation formula, ATR is calculated as:

ATR_n = [ATR_n-1*(n-1) + TR_n]/n 

The above formula replaces one ATR value with the current True Range and recalculates the ATR for the latest period.

Assume the ATR for a 10-day period is 1.50 and the latest TR is 1.55. The latest ATR would be:

ATR = [1.50*(10-1) + 1.55]/10 or 1.505

The approximation method may not yield current results if the previous ATR value is driven by the high True Range of the oldest period. Suppose the True Range values for the last 10 days were 6, 1, 1, 1, 1, 1, 1, 1, 1, and 1. In this data set, “6” is the True Range of the oldest time period and should be eliminated first when the next ATR is calculated. The ATR for the last day would be, say 1.5, and using approximation, the current ATR would be 1.505.

However, based on actual calculation, ATR = (1 + 1 + 1 + 1 + 1 + 1 + 1 + 1 + 1 + 1.55)/10 or 1.055. This is significantly different from 1.505, which was calculated by approximating. This shows the impact of the oldest data in the approximation formula. Since the oldest True Range was very high, it led to a sharp reduction in the latest ATR value once it was eliminated. The approximation method assumed that all 10 days had a True Range of 1.5, and so the impact of removing the oldest data set on the ATR was minimal.

How Does the ATR Indicator Work?

ATR is a measure of volatility, and assets with higher volatility have higher ATRs. Traders can use ATR to place trades based on how the asset behaves. 

Reading the Average True Range Indicator

The Average True Range value increases when the price is highly volatile. During periods of consolidation, the Average True Range has lower values. Since it is a volatility measure, the ATR doesn’t indicate buying or selling pressure. It simply signals when volatility is very high and when you can expect a sharp change in price.

The following chart is an example of how to visualize the Average True Range along with the change in price. Since the ATR measures volatility, it doesn’t use the same scale as price.

The red line in the bottom section represents the ATR line. You can clearly see three peaks. These are periods of extremely high volatility. The peaks are also evident when there is a sharp rise or a sharp drop in the price. Before making any decision based on the Average True Range, a trader should also watch out for the price action and understand the trend.

The ATR peaks form before extreme price movements. That’s why traders commonly use the technical indicator to figure out entry and exit points. Some traders also use a multiplier to detect abnormal price movements (an ATR with a 1.2 multiplier, for example).

How to Use Average True Range for Day Trading?

Average True Range is a very simple tool. You can calculate it based on a few minutes for day trading activities involving assets like foreign exchange, equity, or commodities. The default setting has a length of 14, which the trader can change according to his preference. Longer lengths are less reactive to price changes, whereas shorter lengths are more sensitive.

One of the most straightforward applications of the Average True Range is to identify periods of high volatility. In the chart above, you can see three instances of a volatility spike. The higher the spike, the more substantial the volatility. Cases like these indicate that the price has moved by an amount higher or lower than the historical average. 

Some traders tend to apply a multiplier above the ATR value. In such cases, the trades are only executed when the ATR value reaches a particular value.

It is also important to note that the direction of movement can’t be identified simply by looking at the ATR chart. It is important to complement it with other technical indicators as well.

Examples of ATR Trading

The following intraday chart shows the price of Tesla along with the technical indicators Average True Range and Relative Strength Index (RSI). The RSI (highlighted in purple) is a momentum indicator that shows if the price is in overbought or oversold territory. An RSI value over 70 is a signal for selling the stock since it is in the overbought zone. Likewise, an RSI below 30 gives an indication to buy.

In the area highlighted in blue, there is a spike in the ATR value. Similarly, the RSI value is also above 70. The two indicators give a sell signal. 

The ATR in the above chart is based on single-minute price points. However, in the general case, it can be based on much shorter intervals. Since ATR doesn’t hint at the direction of future price movements, the addition of RSI makes it easier for the trader to decide what position to take. Other technical indicators can also work here to help provide directional calls and improve the trading strategy. Such include trading volume-measuring indicators, moving averages, Bollinger Bands, and more. The ATR is a flexible tool. We can use it across different asset classes, including the derivatives market.

Using the ATR for Futures vs. Stocks

The example above reveals an intraday trading scenario for stocks. However, a trader with a longer time horizon can configure the price chart to a few days. In intraday stocks trading, the leverage is lower than when trading futures contracts or other derivatives. At the same time, this limits the potential loss a trader can make if his price prediction is wrong. 

Therefore, the use of ATR in futures trading can help generate higher returns at the expense of more risk. ATR lines can be handy in volatile futures markets like commodities and foreign exchange. Traders can also use multipliers over the ATR line to create stop-loss triggers.

Like other assets, when applying ATR for futures trading, the trader needs to be wary of the direction the signal is hinting at. Using other technical indicators to complement it is highly advisable, especially when trading derivatives. Since small tick movements can lead to higher gains or losses, it is also essential for futures traders to calculate the ATR for smaller time intervals (minutes instead of hours).

Average True Range Drawbacks

The Average True Range is a robust approach for measuring volatility. Most charting tools allow the addition of the Average True Range. While it is easy to comprehend, the ATR indicator has its disadvantages. Some of them include:

1. ATR isn’t indicative of price jumps or drops: The ATR can peak irrespective of whether the price is expected to rise or fall. This makes it confusing for traders who only observe the ATR for trading signals. It is imperative to use other technical indicators to get a more accurate picture.
2. ATR isn’t useful during a consolidation phase: There is little activity in the ATR line when the price is trending sideways.
3. The ATR can provide an incorrect signal when the trend is extremely strong: When there is a sharp rise or drop in price, the ATR can give a trading signal contrary to market expectations. While the asset may be in overbought territory based on volatility measures, there could be reasons why the uptrend could continue further.

Final Thoughts

There are several volatility-based technical indicators. However, most of them are complicated to interpret. The ATR is a much easier approach to understanding volatility, and the results are pretty straightforward. A trader only needs to configure the period. It is also helpful in validating the outcome of other charting tools and can be used in intraday trading.

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