Beyond the candlestick: Understanding my 2 favourite chart indicators

A Look at the Markets: S&P 500 (SPX)

This is the monthly chart of the S&P 500 - around 500 of the most important stocks in the USA. Each candle represents 1 month so the last candle on the right is August 2024.

Do you remember the volatility and headlines at the beginning of the month? Not only does it look insignificant on the chart only 3 weeks later, but the candle is now green - that means that the price is higher than at the beginning of the month!

Lesson: do not pay too much attention to financial headlines.

As always, we do not know what the future price action will be.

Understanding Charting Indicators: Bollinger Bands & RSI

When I first started exploring financial markets, I was overwhelmed by the sheer number of charting indicators available. Too much information can be worse than no information at all. For that reason, I concentrate on just two indicators which stand out for their simplicity and effectiveness: Bollinger Bands and the Relative Strength Index (RSI). These tools have become essential in my trading toolkit, and I believe they can be invaluable for financial learners looking to understand market conditions.

Furthermore, it will help you understand my charts when I post them in this newsletter.

Bollinger bands

Bollinger Bands are a popular tool among traders for understanding market volatility. Developed by financial analyst John Bollinger, these bands consist of a simple moving average (SMA) and two standard deviation lines. Here's a breakdown of their components:

• Simple Moving Average (SMA): This is the average price over a specified number of periods, commonly 20. So on a daily chart, each point would be the average price of the last 20 days. Each day 1 data point will drop off while another data point is added.

• Upper Band: This is the SMA plus two standard deviations.

• Lower Band: This is the SMA minus two standard deviations.

Let’s compare the basic candle stick chart for Apple with the same chart with Bollinger bands added.

Key Points

• Volatility Indicator: The wider the Bollinger Bands, the more volatile the market or asset is. We can compare the narrow Bollinger bands around April 2024 with the wider Bollinger Bands from May until August

• Momentum: We can see strong momentum from May to July 2024 where the Bollinger Bands were wide and the 20 SMA (blue line) acted as support - a level that it is difficult for the price to drop below. During all this time the price was above the 20 SMA signalling bullish price action.

• Break of support: Notice how when price action eventually did break below the 20 SMA it led to further bearish price action.

• Price action outside the Bollinger Bands: Notice how when the price does break outside the Bollinger Bands (2 standard deviations) it is a signal that the price may correct towards the 20 SMA. This was the case in bullish cases (early May and early June) and a bearish case (early August)

• Backwards-Looking: Like most chart indicators, Bollinger Bands look at historic price action rather than predicting future movements.

Please note that these are called indicators for a reason - they only indicate possible price action and are not rules that price always obeys.

Relative Strength Index

The second indicator that I like and add to my charts is the Relative Strength Index (RSI). This is another fundamental charting indicator and it measures the speed and change or momentum of price action. It ranges from 0 to 100 and is typically used to identify overbought or oversold conditions in a market.

Let’s add RSI to the Apple Chart

Key Points

I mainly use RSI to see when a stock might be overbought or oversold. The area shaded in purple is from 30 - 70 on the RS scale.

• Overbought Conditions: An RSI above 70 (above the purple shading) suggests that an asset may be overbought. We can see this in June and July 2024 and this, combined with the Bollinger Bands being outside 2 standard deviations suggests a possible bearish price correction.

• Oversold Conditions: An RSI below 30 indicates that an asset may be oversold. We can see this in March 2024 and, again, there was a small bullish price correction.

• Momentum Indicator: RSI helps in understanding the momentum of price movements. Rising or falling RSI represents positive or negative momentum.

Conclusion

Understanding Bollinger Bands and RSI can provide valuable insights into market conditions. These indicators are not foolproof and should be used as guides rather than prediction tools. By incorporating them into your analysis, you can better navigate the complexities of financial markets.

Kamala Harris Aide Signals Crypto Support

Democratic presidential candidate Kamala Harris will support policies to encourage the growth of the cryptocurrency industry, a senior advisor said on Wednesday.

While this may only indicate a small change of policy it is the direction that is important. The Republicans have also indicated a pro-crypto stance at the next election.

I believe that, as the adoption rate of cryptocurrencies continues to increase, all political parties will have to become increasingly supportive of crypto - there are too many votes to be won or lost!

Word of the Day - Momentum

Momentum - noun - the force that keeps an object moving