In the "Key concepts" section, we explain the basic concepts of trading that are necessary, above all, for understanding our strategy articles. The aim is to introduce beginners to complex strategies and at the same time give advanced traders the opportunity to refresh their basic knowledge.
Average Directional Index (ADX)
The ADX is an indicator that represents a determination of trend strength. While the two sub-indicators +DI and -DI mainly determine the trend direction, the ADX is used exclusively to determine the trend strength. The ADX is the smoothed variant of the Directional Movement Index (DMI), which is calculated from +DI and -DI. ADX values above 20 point to an existing trend. Values above 30 indicate a clear trend, values above 40 are interpreted as particularly strong trends.
Let us briefly summarise the calculation: The two sub-indicators +DI and -DI are determined by first determining the upward and downward price changes. These values are smoothed and divided by the also smoothed true range (see ATR description). The smoothed upward price changes, known as +DM (Positive Directional Movement), divided by the smoothed true range give the +DI (Positive Directional Index). The smoothed downward price changes, known as -DM (Negative Directional Movement), divided by the smoothed true range give the -DI (Negative Directional Index). The DMI is calculated as the absolute value of the difference between +DI and -DI divided by the sum of +DI and -DI multiplied by 100. By default, the ADX is calculated as the moving average of the DMI over 14 periods.
Image 1: The ADX shows when a trend prevails (high values) and when it does not (low values).
Average True Range (ATR)
The True Range and its smoothed version, the ATR, were developed by Welles Wilder in 1978. Wilder was looking for a way to capture the volatility of commodity and futures markets in one indicator. All methods used to date, such as simple arithmetic averages of the daily trading range, produced insufficient results and neglected price gaps between the closing price and the subsequent opening price. In addition, the movements of some commodity futures contracts are limited by limits, which may result in no highs or lows being recorded. The true range is the highest of the three:
(1) High (today) - Low (today)
(2) High (today) - Closing price (day before)
(3) Closing price (day before) - Low (today)
By default, the ATR is calculated as the moving average of the true range over 14 periods.
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The Fibonacci numbers are an infinite sequence. A Fibonacci number is calculated by adding the two preceding numbers. The sequence starts with 0 and 1. All following numbers result automatically: 2, 3, 5, 8, 13 and so on. Fibonacci numbers and ratios often occur in nature; their application in technical analysis also transfers this to the financial markets. Fibonacci retracements - in the sense of returns or corrections - are determined by first searching for two extreme points in the chart, a low and a high. This distance corresponds to 100 percent of the movement. Based on this, the retracements are different correction levels such as 38.2, 50 or 61.8 percent. These values result from the formation of different quotients in the Fibonacci number sequence.
Image 2: Fibonacci retracements
Image 2: Shown is a 38.2% Fibonacci retracement on adidas. From the price increase in mid-September to the end of December 2013, the share corrected intraday by 38.2% in January, almost to the nearest cent (see marker), at the same time closing the remaining gap from mid-December and then rising again.
In the 1980s, soybean trader Peter Steidlmeier developed the Market Profile together with the Chicago Board of Trade (CBOT) in order to gain a better insight into the markets. The Market Profile is based on the assumption that markets are determined by price, time and volume. Every day, the market develops a daily range and a specific value zone. The latter is the price level where the interest of buyers and sellers is balanced and the volume is maximum. On the vertical axis of the Market Profile the price is plotted, on the horizontal axis the time. Over a certain period of time, it is easy to see in which areas the largest volume has taken place. From this, in turn, it can be deduced which price level appears "fair" or at which levels promising trades are available. If, for example, prices leave the value zone at low volumes, it is likely that there will be no breakout and that prices will return to equilibrium - this makes anti-cyclical trades interesting. If, on the other hand, the volume is high when leaving the value zone, the market is re-organised with regard to the equilibrium price.
The stochastic oscillator is one of the most widely used technical indicators. It compares the last closing price of a security with the development of its price range within a specified time period. The stochastic is based on two lines. The %K line compares the last closing price with the price range of the last n days. In the uptrend, the closing price is in the upper range of this range and may stay there for longer periods of time. In the downtrend, the closing price is in the lower range of this range and may stay there for longer. The %D line is a moving average of the %K line. The scale of the indicator is between zero and 100. Values above 80 are considered overbought, where a corresponding extreme zone is marked. Values below 20 are considered oversold, where a corresponding extreme zone is also marked. In addition, we can draw the midline at 50. Stochastic values close to 100 indicate that the underlying asset is traded at the high of the period under consideration. Stochastic values close to zero indicate that the underlying is trading at the low of the time period under consideration. In addition to the extreme zones, traders can also trade the crossing of the %K and %D lines. The Stochastic, like most other indicators, is best used in combination with other indicators.
Image 3 shows the stochastic oscillator for Deutsche Telekom shares. Like all oscillators, it works best in sideways phases or slight trends with stronger fluctuations. According to the classic interpretation, a buy-signal is generated when the stochastic (blue line) crosses the 20 line from below to above, and a sell-signal when it crosses the 80 line from above to below. In addition, crossing the stochastic line with the purple signal line, which represents a moving average of the stochastic, can be traded.