For momentum trading, which is a type of technical trading, a trader watches for signs that a stock is about to pop; that is, to undertake a significant unidirectional price movement on high volume for a sufficient period of time that might bring a profit. By virtue of watching the momentum line, the momentum trader has already engaged in technical analysis by examining stock charts for signs of the breakout.
The technical indicators used in momentum trading are only the tip of the iceberg; they are only a small sampling of the wide range of chart and graph patterns available to the technical trader.
Before we focus on technical trading, here's a review of the main types of equity trading:
Novice traders might experiment with each of these techniques, but they should ultimately settle on a single niche matching their investing knowledge and experience with a style to which they are motivated to devote further research, education, and practice. Entire textbooks are devoted to each style although many titles such as "Day Trade Online" or "How to Get Started in Electronic Day Trading" are unclear about what type of trading they espouse.
Technical trading is a broader style that is not necessarily limited to trading. Generally, a technician uses historical patterns of trading data to predict what might happen to stocks in the future. This is the same method practiced by economists and meteorologists: looking to the past for insight into the future. However, we all know how poor forecasts can be.
The challenge of technical analysis is that there are literally hundreds of technical indicators available, and there is no single indicator that is considered universally better as each particular indicator or group of indicators, that may be applicable only to specific circumstances. Some technical indicators may be useful for certain industries, others only for stocks of a certain classification (for example, stocks within a certain range of liquidity or market capitalization). Because of the unique patterns that highly traded stocks might exhibit throughout history, some indicators may be relevant only to certain individual stocks.
Technical indicators, like momentum indicators, are not a silver bullet for deciding when to buy or sell. They are poor predictors of precise timing, but they are good at indicating which stocks are candidates for further analysis with such detailed data as the Level 2 screen. As such, technical analysis can be viewed as a starting point—the historical patterns do not necessarily translate into an exact picture of future performance.
Instead of trying to provide an exhaustive study of all of the indicators available to the technical trader, we discuss the most common groupings and provide a general introduction to each. This discussion is limited to indicators applicable to individual stocks—there are many indicators that might be useful to predict an index or industry group.