The Three Families of Indicators

Three questions, three families

Almost every indicator you will meet belongs to one of three families, and the family tells you which question it is built to answer.

• Trend indicators answer "which way?" Moving averages, MACD, ADX, SuperTrend, Ichimoku, Parabolic SAR. They smooth price so direction is visible, and they work best when a market is actually going somewhere.
• Momentum indicators answer "how hard, and is it fading?" RSI, Stochastic, ROC, Williams %R, CCI. They measure the speed and magnitude of recent moves, usually as a bounded oscillator, and they are most useful for spotting weakening thrust — not for calling tops.
• Volatility indicators answer "how much does it normally move?" ATR, Bollinger Bands, Keltner Channels. They quantify the size of movement itself, which is what stop placement and position sizing actually depend on.

Why the distinction saves you money

The classic beginner error is using a momentum indicator to answer a trend question. You see RSI above 70 in a strong uptrend, read "overbought", and short it. But RSI is not saying price is too high — it is saying the recent moves up have been large relative to the recent moves down, which is exactly what a healthy uptrend looks like. You used a momentum reading as a reversal signal and got run over.

Match the family to the question. Want direction? Use trend. Want to know whether the thrust behind a move is fading? Use momentum. Want a stop distance? Use volatility.

The fourth thing: volume

Volume-based indicators — OBV, MFI, Chaikin Money Flow, the volume oscillator — sit slightly outside the three families. They compare price movement against the volume behind it, on the theory that a move on heavy volume is more meaningful than the same move on thin volume. Useful, but be aware that on many retail CFD platforms the volume feed is the broker's own tick volume rather than exchange volume, so it is indicative rather than exact.

How to check this yourself

Pick one market and put three indicators on it at once, one from each family: a 50-period moving average (trend), RSI(14) (momentum) and ATR(14) (volatility). Now ask each one its own question in turn — which way, how hard, how much does it move. Notice that they frequently disagree, and that the disagreement is not a contradiction: they are measuring three different things. Learning to read that disagreement is most of technical analysis.