Top 10 Technical Analysis Indicators for Trading and Investing

Technical analysis
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Top 10 Technical Analysis Indicators for Trading and Investing

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There are many different indicators that can be used in technical analysis, and different traders may have different preferences for which ones they use. Any modern software has all of these available at the click of a button.

You don’t necessarily need to know how to calculate each technical analysis indicator, but you should know how to use them.

When a few of the technical indicators show buy signs and the company fundamentals align, that’s when you know it’s a good stock pick. Of course, you can’t predict that for sure you won’t lose money on a particular investment even if it seems perfect. However, the more technical indicators you use, the more confident you can be in your picks.

What is Technical Analysis?

Think of technical analysis like your car’s GPS. When you’re driving, you don’t just look at the road directly in front of you, right? You use your GPS to understand the road layout, traffic conditions, and even alternate routes. Similarly, technical analysis helps you navigate the stock market and other investments with price charts.

Instead of forecasting the future, it looks at past market data—mainly price and volume—to figure out possible future price trends. It’s like using the history of how fast you’ve been driving to predict when you might reach your destination.

How Does Technical Analysis Work?

Technical analysis revolves around charts and indicators. Ever seen a meteorologist point out patterns on a weather map? It’s a bit like that, but instead of cloud formations, we’re looking at price patterns and trading signals on a stock chart.

And those indicators we mentioned? They’re like the different tools your GPS uses to calculate your ETA. Some might measure the speed of the market (momentum), others might reveal if a stock is a potential bargain (oversold), or if it might be a little too popular (overbought).

Making Sense of the Market’s Mood

The goal of technical analysis is to make sense of the market’s mood. Is it bullish and confident, driving prices up? Or is it bearish and cautious, nudging prices down? Technical analysis helps us understand these sentiments.

And remember, much like your GPS isn’t the be-all and end-all of your road trip, technical analysis isn’t a crystal ball. It’s a tool, one of many in your investing toolbox, and works best when paired with other types of analysis.

Now let’s dive into the top 10 technical analysis indicators:

  1. Moving Averages
  2. Bollinger Bands
  3. Relative Strength Index (RSI)
  4. Stochastic Oscillator
  5. Moving Average Convergence Divergence (MACD)
  6. On-Balance Volume (OBV)
  7. Fibonacci Retracement
  8. Average Directional Index (ADX)
  9. Ichimoku Cloud
  10. Parabolic SAR (Stop and Reverse)

1. Moving Averages

A Moving Average (MA) is a technical analysis indicator that is commonly used to identify trends in the price of a security. It does this by calculating the average price of a security over a certain period of time and then plotting that average on a chart. It helps smooth out the daily price fluctuations, giving us a clearer picture of the stock’s price trend over time.

There are different types of moving averages, but the two most commonly used are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).

  • The simple moving average is calculated by taking the sum of the closing prices of a security over a specified number of periods and then dividing that sum by the number of periods.
  • The Exponential Moving Average is a type of moving average that gives more weight to recent price data. In other words, it’s quicker to respond to price changes than the Simple Moving Average.

For example, if you wanted to calculate a 50-day Simple Moving Average for a stock, you would add together the closing prices for the stock over the last 50 trading days and then divide that sum by 50.

The Exponential Moving Average is a bit different and might sound like a scary math equation from your high school days, but don’t fret. Just remember, it’s all about giving more importance to the recent data.

Here’s how it works:

Let’s imagine a stock that has had the following closing prices over the last 5 days:

  • Day 1: $10
  • Day 2: $11
  • Day 3: $12
  • Day 4: $13
  • Day 5: $14

The Simple Moving Average (SMA) for the above data would be $12 [(10+11+12+13+14) ÷ 5].

For the EMA, we need to introduce the “smoothing factor.” This factor is calculated using the following formula:

  • Smoothing factor = 2 ÷ (number of time periods + 1)

For a 5-day EMA, the smoothing factor would be 2 ÷ (5+1) = 0.33

Then, we use this smoothing factor to calculate the EMA. We start with the SMA for the first calculation and then apply the following formula for all subsequent ones:

  • EMA = (Closing price – Previous day’s EMA) * smoothing factor + Previous day’s EMA

But how do we get the previous day’s EMA, especially for the first day?

In practice, for the very first EMA calculation, we typically use the Simple Moving Average (SMA) of the previous days as the “Previous EMA”. After we have this first EMA value, we can then use the EMA formula for each subsequent day, using the EMA of the previous day.

To illustrate, if you are calculating a 5-day EMA and today is the 6th day, you would use the SMA of the first 5 days as the “Previous EMA” in the formula for the 6th day. From the 7th day onwards, you would use the actual EMA from the previous day in the EMA formula.

So, for Day 6, if the closing price is $15, the EMA would be ($15 – $12) * 0.33 + $12 = $12.99

This means that while the SMA was $12, the EMA is $12.99, indicating a sharper response to the price increase.

A moving average is useful for identifying trends, by looking at the direction of the moving average:

  • If the moving average is moving upward, then that can indicate that the stock is in an uptrend.
  • If the moving average is moving downward, then that can indicate that the stock is in a downtrend.
SMA EMA
The chart was generated using Tradingview. The blue line represents the SMA and the green line represents the EMA.

2. Bollinger Bands

Bollinger Bands are a technical analysis tool that consists of a moving average and two standard deviation lines, one above and one below the moving average. These bands are used to measure volatility in a stock or other financial instrument. If the stock price is moving within the bands, it is considered to be less volatile, while if the stock price is moving outside of the bands, it is considered to be more volatile. Traders use Bollinger Bands to help identify potential buying or selling opportunities by looking for patterns and trends in the stock price in relation to the bands.

  • When the stock price breaks above the upper band, it may indicate a potential buying opportunity. That’s because it may be a continuation pattern to new highs.
  • If the stock price is consistently near the upper band, it may indicate that the stock is overbought and a potential sell opportunity.
  • If the stock price is consistently near the lower band, it may indicate that the stock is oversold and a potential buying opportunity.
  • When the stock price falls below the lower band, it may indicate a potential selling opportunity. That’s because it may be a continuation pattern to new lows.

It’s important to note that Bollinger Bands are a tool used in conjunction with other analyses and should not be relied upon exclusively to make trading decisions.

Bollinger Bands buy signal
The chart was generated using Tradingview. The buy signal can be seen when the price moves above the upper Bollinger Band.

3. Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a technical indicator that compares the magnitude of a stock’s recent gains to the magnitude of its recent losses, in order to determine overbought or oversold conditions of an asset. It is a popular momentum oscillator and is used to identify when a stock is overbought (has been rising too fast) and oversold (has been falling too fast). The RSI is calculated by taking the average gain of a stock over a certain period and dividing it by the average loss over the same period. More specifically:

  1. Determine the number of periods you want to use for the calculation, typically 14 days is used.
  2. Next, calculate the average gain of the stock over the number of periods you selected. This is done by adding up all of the positive price changes during that time period and dividing by the total number of periods from the first step above.
  3. Then, calculate the average loss of the stock over the same number of periods. This is done by adding up all of the negative price changes during that time period and dividing by the total number of periods from the first step above. Use absolute values.
  4. Next, calculate the relative strength (RS) by dividing the average gain by the average loss.
  5. Finally, the RSI is calculated using this formula: RSI = 100 – (100 / (1 + RS))

The resulting value oscillates between 0 and 100. A stock is considered:

  • Overbought if its RSI value is above 70.
  • A value between 50-70 usually indicates that a stock is trending up.
  • A value between 30-50 usually indicates that a stock is trending down.
  • Oversold if its RSI value is below 30.
RSI overbought
The chart was generated using Tradingview. RSI 14 technical indicator in action. You can see the overbought signal by looking at the RSI at the bottom. It’s above 70.

4. Stochastic Oscillator

As we continue our investment journey, let’s sail towards a new horizon, and this time, we’re navigating with the Stochastic Oscillator. Don’t be thrown off by the name. Like our old friend the Moving Average, this is just another tool to guide us on our investment journey. Let’s explore.

What’s a Stochastic Oscillator?

Think of the Stochastic Oscillator as your investment compass. It’s a momentum indicator that compares a particular closing price of a security to a range of its prices over a certain period of time. The idea behind it is that as a security’s price increases, its closing price will be closer to the high end of its recent price range.

Breaking Down the Stochastic Oscillator: A Hands-on Example

Let’s say we’re looking at a stock over a 14 day period. During that time, the highest price the stock reached was $150, and the lowest was $100. On the 14th day, the stock closed at $145.

The Stochastic Oscillator is calculated using this formula:

%K = [(Today’s Close – Lowest Low) / (Highest High – Lowest Low)] * 100

In our example:

%K = [(145 – 100) / (150 – 100)] * 100 = 90%

The resulting 90% is the Stochastic Oscillator value for the 14th day, suggesting the closing price is near the top of the 14-day range.

Buy and Sell Signals

The Stochastic Oscillator can provide buy and sell signals. Traditionally, a value above 80% is considered “overbought,” indicating potential selling opportunities. Conversely, a value below 20% is viewed as “oversold,” signalling a possible buying opportunity.

In our example, the 90% value is above 80%, indicating that the stock may be overbought. It might be a good time to consider selling. But remember, it’s just a signal, not a guarantee. Other factors should also be considered.

Overbought and Oversold Levels

When the Stochastic Oscillator shows a value above 80%, it means the security is trading near the top of its high-low range. That’s the overbought zone, and it can signal that a price correction might be on the horizon. But tread with care: prices can stay in the overbought zone for a while in a strong uptrend.

Similarly, when it’s below 20%, it means the security is near the bottom of its range, or in the oversold zone. It may signal that prices might rebound. But again, prices can stay in the oversold zone during a strong downtrend.

Stochastic Oscillator
The chart was generated using Tradingview. Here is the Stochastic Oscillator in action. When it goes below 20%, it’s a buy signal. When it goes above 80%, it’s a sell signal.

5. MACD (Moving Average Convergence Divergence)

Let’s turn the dial on our investment radio tune into MACD – Moving Average Convergence Divergence. This little gadget is not just about big words but big insights about market trends.

What’s a MACD, Really?

In a nutshell, the MACD indicator is like a weather vane, helping traders spot the direction of the trend – whether it’s taking a bullish stride upwards or taking a bearish dip. But that’s not all. MACD is like a good dance partner; it keeps up with the rhythm and momentum of that trend. And if you know where to look, it can even whisper potential trading signals in your ear.

How the MACD Plays Out: Let’s Break it Down

The MACD twirls around zero. When it’s grooving above zero, it means the price trend is stepping up to a bullish beat. But if the MACD swings below zero, it’s entered bearish territory.

Now, the MACD isn’t just one line, it’s two: the MACD line that loves to swing around, and a signal line, which prefers to take things slow. When the MACD line cuts across the signal line from above, the price trend might be dropping. But if the MACD line sashays past the signal line from below, the price could be climbing.

Reading the MACD

Keeping an eye on where the MACD is going relative to zero can help you decide which signals to follow. If the MACD is moving above zero, watch for it to cross above the signal line – that’s your cue to join the bulls. But if the MACD is below zero and crossing below the signal line, it might be a sign to take a breather, stay on the sidelines, or even consider a short trade.

One important thing to remember is that MACD, like any dance step, isn’t perfect. It’s part of your dance routine, a routine that should include other indicators as well. It’s also worth noting that MACD moves in tune with the price trend, so it’s always a step behind the actual price. It’s like following the beat of the music, not making the music itself.

MACD buy and sell signals
The chart was generated using Tradingview. Here is the MACD in action. When it goes below 0, it’s a sell signal. When it goes above 0, it’s a buy signal.

6. On-Balance Volume (OBV)

On-Balance Volume (OBV) is a momentum indicator that uses volume flow to predict changes in the price of a stock, commodity, or other traded asset. The theory behind OBV is that changes in volume often precede price changes, making it a leading indicator.

The OBV is calculated by adding the day’s volume to a running cumulative total when the security’s price closes up, and subtracts the volume when the security’s price closes down.

Here’s an example:

Let’s say a stock’s closing prices and volumes over three days are as follows:

  • Day 1: Closing price is $20, volume is 1,000
  • Day 2: Closing price is $21, volume is 1,500
  • Day 3: Closing price is $20.50, volume is 2,000

The OBV for each day would be calculated as follows:

  • Day 1: OBV is not applicable because it’s the first day.
  • Day 2: Because the closing price increased from day 1 to day 2, the volume for day 2 (1,500) is added to the OBV, so the OBV for day 2 is 1,500.
  • Day 3: Because the closing price decreased from day 2 to day 3, the volume for day 3 (2,000) is subtracted from the OBV, so the OBV for day 3 is -500 (1,500 – 2,000).

If the volume is increasing when the price is maintaining an upward trend, it is typically a bullish signal. Conversely, if the price is in a downtrend and volume is increasing, this is usually a bearish signal.

Buy and Sell Signals

When the OBV increases in the direction of the price trend, it confirms that trend. If the price is rising but OBV is falling, it could indicate that the trend is not backed by strong buyers and could soon reverse. This is seen as a sell signal. Conversely, if the price is falling and OBV is rising, it shows strong buying pressure, which could precede a price uptick. This is viewed as a buy signal.

Overbought and Oversold Levels

Unlike oscillators such as the RSI, OBV does not have a range and therefore does not provide overbought or oversold levels. However, you can look for divergences between OBV and price to identify potential reversals. For instance, if the price is making new highs but OBV isn’t, it could signal that the uptrend is running out of steam and is due for a correction.

Remember that like any other indicator, OBV should not be used alone but rather with other indicators to confirm signals and prevent false ones.

OBV sell signal
The chart was generated using Tradingview. Here is the OBV in action. When it’s increasing, it’s a buy signal. When it decreases, it’s a sell signal.

7. Fibonacci Retracement

Fibonacci Retracement is a popular technical analysis tool that uses horizontal lines to indicate where potential support and resistance levels lie. Each level is associated with a percentage: 23.6%, 38.2%, 50%, 61.8%, and 100%. These percentages are based on the Fibonacci sequence, a mathematical concept discovered by Leonardo Fibonacci in the 13th century.

Here’s how you could use the Fibonacci retracement:

Step 1: Identify a significant peak and trough on the price chart. The distance from peak to trough is what will be used to calculate the Fibonacci retracement levels.

Step 2: Draw a line from the peak to the trough (for a downtrend) or from the trough to the peak (for an uptrend). This is often done using charting software.

Step 3: The software automatically applies the Fibonacci ratios (23.6%, 38.2%, 50%, 61.8%, 78.6 %, and 100%) to the distance between the peak and trough and plots horizontal lines at these price levels.

Step 4: Look for signs of a price reversal when the price reaches these levels. A price reversal might be indicated by a change in the direction of a candlestick chart, a change in volume, or a change in another technical analysis indicator.

For example, if a stock rises from $10 (trough) to $20 (peak), and then starts to retrace, the Fibonacci retracement levels would be:

  • 23.6% retracement = $17.64 (23.6% below the peak of $20)
  • 38.2% retracement = $16.18 (38.2% below the peak)
  • 50% retracement = $15 (50% below the peak)
  • 61.8% retracement = $13.82 (61.8% below the peak)
  • 78.6% retracement = $12.14 (78.6% below the peak)

So, if the price of the stock falls to $17.64 and then starts to rise, you might interpret that as a buy signal, indicating that the price is bouncing off the 23.6% retracement level.

Buy and Sell Signals

Traders often look to buy when the price bounces off a Fibonacci support level (indicating a reversal of the downtrend), and sell when the price bounces down off a Fibonacci resistance level (indicating a reversal of the uptrend).

Overbought and Oversold Levels

The Fibonacci retracement is not typically used to indicate overbought or oversold conditions like RSI or Stochastic Oscillator. However, if the price reverses near a Fibonacci level, it could suggest that the recent push was too strong (overbought) or too weak (oversold). Some traders also use extensions (levels beyond 100%) to suggest overbought or oversold conditions.

Keep in mind, like any other technical analysis tool, Fibonacci retracement levels are not foolproof. They should be used in conjunction with other indicators to increase the probability of making a successful trade.

Fibonacci Retracement
The chart was generated using Tradingview. Here is the Fibonacci Retracement in action. When the price touches the resistance level on the fibonacci line and starts increasing, that’s a bullish sign.

8. Average Directional Index (ADX)

The Average Directional Index (ADX) is a technical indicator used to measure the strength of a trend. It does not predict the direction of the trend, only its strength. The ADX ranges from 0 to 100 and is non-directional, meaning it will rise whether the price is trending up or down.

Interpreting ADX Values

The value of the ADX helps traders to determine whether the market is trending and worth trading (trending market have ADX > 25) or it is ranging and should be avoided (non-trending market have ADX < 20).

  • If the ADX is below 20, the trend, if any, is weak.
  • If the ADX is above 25, the trend is strong.
  • If the ADX is rising, the trend is becoming stronger.
  • If the ADX is falling, the trend is becoming weaker.

Buy and Sell Signals

The ADX itself does not provide buy or sell signals, it merely indicates the strength of the current trend, be it up or down. For buy and sell signals, traders often use the +DI and -DI values:

  • If +DI crosses above -DI, this might be a potential buy signal.
  • If -DI crosses above +DI, this might be a potential sell signal.

Traders should confirm these signals with other technical analysis tools or indicators.

Overbought and Oversold Levels

The ADX does not provide overbought or oversold levels because it’s a non-directional indicator. It merely shows whether the price is trending or not, and how strong the trend is.

Like all indicators, the ADX is not infallible and it can often lag the market, so it should be used in conjunction with other types of analysis to increase the accuracy of its predictions.

ADX strong trend
The chart was generated using Tradingview. Here is the ADX in action. When the ADX is above 25, it’s a strong trend.

9. Ichimoku Cloud

The Ichimoku Cloud, also known as Ichimoku Kinko Hyo, is a versatile indicator that provides more data points, thereby providing a more comprehensive depiction of potential support and resistance levels, as well as momentum and trend direction.

The Ichimoku Cloud consists of five lines:

  1. Tenkan-sen (Conversion Line): This is the midpoint of the highest and lowest prices over the last nine periods. It’s an indicator of short-term price movement.
  2. Kijun-sen (Base Line): This is the midpoint of the highest and lowest prices over the last 26 periods. It’s an indicator of medium-term price movement.
  3. Senkou Span A (Leading Span A): This is the midpoint of the Tenkan-sen (Conversion Line) and Kijun-sen (Base Line), plotted 26 periods into the future. It forms one edge of the Ichimoku cloud.
  4. Senkou Span B (Leading Span B): This is the midpoint of the highest and lowest prices over the last 52 periods, plotted 26 periods into the future. It forms the other edge of the Ichimoku cloud.
  5. Chikou Span (Lagging Span): This is the current closing price, plotted 26 periods into the past.

Here’s how you might use the Ichimoku Cloud:

Step 1: Identify where the price is in relation to the cloud. If the price is above the cloud, the overall trend is bullish. If the price is below the cloud, the trend is bearish.

Step 2: Look for the cloud color. If Senkou/Leading Span A is above Senkou/Leading Span B, the cloud is green (bullish), and if Senkou/Leading Span B is above Senkou/Leading Span A, the cloud is red (bearish).

Step 3: Check the positions of the Tenkan-sen (Conversion Line) and Kijun-sen (Base Line). A bullish signal is given when the Tenkan-sen (Conversion Line) crosses above the Kijun-sen (Base Line); this is called a bullish TK cross. A bearish signal is given when the Tenkan-sen (Conversion Line) crosses below the Kijun-sen (Base Line); this is called a bearish TK cross.

Buy and Sell Signals

The simplest trading strategy using the Ichimoku cloud is to buy when the price moves above the cloud (indicating a bullish trend) and sell when the price moves below the cloud (indicating a bearish trend).

However, more nuanced strategies may take into account other elements, like the TK cross. For example, a bullish TK cross in conjunction with the price above the cloud may provide a strong buy signal, while a bearish TK cross with the price below the cloud may suggest a strong sell signal.

Overbought and Oversold Levels

The Ichimoku Cloud doesn’t provide traditional overbought or oversold levels. However, when the price is far away from the Kijun-sen (Base Line), it could be seen as overextended, and a correction may soon occur.

Keep in mind that, as with all indicators, the Ichimoku Cloud should not be used in isolation. It should be combined with other forms of analysis to increase the accuracy of its signals.

Ichimoku Cloud Bullish Trend
The chart was generated using Tradingview. Here is the Ichimoku Cloud in action. The price moved above the cloud, indicating a bullish trend.

 

Here's the legend for the chart above.
Here’s the legend for the chart above.

10. Parabolic SAR (Stop and Reverse)

Parabolic SAR (Stop and Reverse) is a technical analysis indicator developed by Welles Wilder. It’s used to determine the direction of an asset’s momentum and the point in time when this momentum has a higher-than-average probability of switching directions.

In a chart, the Parabolic SAR takes the form of dots that are placed either above or below the price line of an asset depending on the direction of the momentum.

Here’s how to use it:

Step 1: Identify the dots of the Parabolic SAR. If the dots are below the price, the trend is bullish, and if they are above the price, the trend is bearish.

Step 2: Watch for when the dots flip. This means that they go from being below the price to above the price, or vice versa. This is a signal that the trend might be about to change direction.

Buy and Sell Signals

The Parabolic SAR generates a buy signal when the dots move from above the price to below the price. Conversely, it gives a sell signal when the dots move from below the price to above the price.

Overbought and Oversold Levels

The Parabolic SAR doesn’t provide traditional overbought or oversold levels. Its primary function is to provide stop-loss signals and indicate potential trend reversals. However, if the price is consistently hugging the upper Parabolic SAR dots in an uptrend (or lower dots in a downtrend), it may suggest an overextended market.

Again, while Parabolic SAR can be a valuable tool for traders, it is often used in conjunction with other technical analysis indicators to confirm trends and reduce the likelihood of false signals.

Parabolic SAR buy and sell signals
The chart was generated using Tradingview. Here is the SAR in action. When the dots move from below the price to above, it’s a sell signal. When the dots move from above the price to below, it’s a buy signal.

Final Thoughts

It’s important to note that no single indicator is likely to provide a complete picture of a security’s price movements, so traders often use multiple indicators in combination to make more informed decisions.