✔️ Information reviewed and updated in November 2023 by Eduardo López
It is normal to see that traders use many tools to support their strategies such as indicators. For starters, trading indicators such as trading zones are critical to better understanding technical analysis. Its main function is to help traders to identify the signals and trends that exist within the market.
For this reason, it is important that before wanting to operate in the investment world you learn to differentiate the functions that each of the tools offer you.
As we told you, the indicators are considered visual tools of great support to determine a price and its evolution. In this article, we tell you more about the trading zone indicator, a technical indicator that is usually plotted on a price chart with upper and lower limits.
➡✨Definition of the trading areas indicator
This indicator is a tool that helps to identify the upper and lower bands of a trading range.
Two moving average envelopes are plotted on a price chart, one moving upward a certain distance and one moving downward. If the market price crosses these bands, then an importance is assigned to the movement and we proceed to operate.
➡✨ What are the negotiation areas for?
The trading zone indicator is used to help traders and investors identify extreme conditions of overbought, oversold, and trading ranges.
The lower and upper bands of this indicator serve as support and resistance in a non-trend market, such as Bollinger bands.
➡✨ How do you get the negotiation zones?
This indicator works by locating trading bands above and below the price level of the instrument that we have chosen. The most common methodology is to calculate a moving average of the price. This is usually a simple moving average.
An upper envelope is created by moving the simple moving average some distance above the price. In this way, a lower envelope is created by moving the simple moving average the same distance below the price.
In other words, it is a moving average of a period n that is applied to the closing price. The upper band is obtained by adding a percentage with respect to the data of this average, and the lower band is obtained by subtracting the same percentage with respect to the data of the same moving average.
How is it interpreted?
It can be interpreted in many ways, but most traders use it to define trading ranges. When the price reaches the upper limit, the security is considered overbought and a sell signal is generated.
On the other hand, when the price reaches the lower limit, the security is considered oversold and a buy signal is generated. The strategies of this indicator are based on mean reversion principles.
Upper and lower limits are typically defined, so price tends to stay within thresholds during normal conditions. To have a more volatile security, traders use higher percentages to avoid other signals.