A confirmation indicator in stock trading is a technical tool or indicator used by traders and analysts to validate or “confirm” the signals generated by other primary indicators or trading strategies.
Confirmation indicators are a critical part of technical analysis, helping traders to verify the validity of signals and improve their trading strategies. By providing additional layers of verification, these indicators enhance the robustness of trading decisions, helping traders to mitigate risk and improve the chances of successful trades.
The purpose of a confirmation indicator is to provide additional evidence that supports a potential trading decision, such as entering or exiting a trade.
While many technical indicators can serve as confirmation indicators depending on the strategy, here are some commonly used ones:
Volume: Volume is one of the most common confirmation indicators. A price movement accompanied by high volume is generally considered more significant than a movement on low volum. For example, if a stock breaks out above a resistance level, higher-than-average trading volume can confirm the breakout’s strength.
Moving Average Convergence Divergence (MACD): MACD is often used to confirm the trend indicated by other indicators. If a trader sees a bullish signal (like a moving average crossover), they might look at the MACD to see if it’s also showing bullish momentum.
Relative Strength Index (RSI): RSI can confirm overbought or oversold conditions. For example, if a stock is breaking down from a support level, a high RSI (indicating overbought conditions) could confirm a potential downtrend continuation.
On-Balance Volume (OBV): OBV tracks volume flow and can confirm price trends. A rising OBV while prices are rising indicates accumulation, confirming a bullish trend.
Stochastic Oscillator: This indicator compares a security’s closing price to its price range over a specific period. It can be used to confirm price momentum or reversals. For example, a trader might wait for a stochastic crossover to confirm a buy signal from another indicator.
ADX (Average Directional Index): ADX measures the strength of a trend. If a trend-based indicator (like a moving average crossover) gives a signal, a rising ADX can confirm that the trend is gaining strength.
Candlestick Patterns: Specific candlestick patterns (such as Doji, Hammer, Engulfing patterns) are often used to confirm signals given by other indicators. For instance, a bullish engulfing pattern at the end of a downtrend might confirm a reversal.