If you are only at the beginning stages of your trading story, one of the most crucial things you should master is technical analysis. Technical analysis is a trading discipline that helps predict the direction of prices based on patterns of their behavior in the past. To draw the right conclusions and choose appropriate strategies, traders rely on various stock market indicators. Read this article to learn about the most popular market indicators.
What are stock indicators?
Stock indicators are tools that help traders identify future movements of the price of particular shares. They include moving averages, Bollinger bands, the MACD indicator, and many others. Technical indicators are used by traders to strategically analyze and trade the stock market in the most profitable way. The indicators are widely used within the area of technical analysis.
Types of stock indicators
To begin with, there are leading and lagging indicators. Leading indicators are designed to predict short-term trends that are about to start. The stochastic oscillator, RSI, and MACD are examples of the leading indicators. Lagging indicators, on the contrary, look back at historical performance, helping to determine a trend. The most commonly used lagging indicator is the moving average.
Every leading and lagging indicator can be referred to one of the following groups:
- Trend indicators identify the direction and strength of a trend. We will review such trend indicators as the moving averages and the MACD;
- Momentum indicators measure the speed of the price movement by comparing the current closing price with the previous closing price. The most commonly used momentum indicators are the Stochastic oscillator and the RSI described further below;
- Volatility indicators identify the rate of price changing, but, unlike trend indicators, ignore the direction of this change. The Bollinger bands and the Standard deviation are worth mentioning when talking about this group of indicators;
- Volume indicators unsurprisingly measure the volume of a trend.
Top 10 trading indicators
The moving averages (MA)
The moving average is a widely used technical indicator. This is a lagging indicator that helps to filter false signals and determine the average price of a stock. The moving average identifies trends and confirms reversals. When the price goes above the moving average it signals that the instrument is in an uptrend while the prices below the moving average are considered to be in a downtrend. When the price breaks the moving average it implies a trend reversal.
Other important concepts related to this indicator are support and resistance levels. Support level serves as a limit for the market's range of movement when the price is up. Resistance level conversely limits the range when the price is down.
The moving average indicates whether a trend is up, down, or if it’s ranging. It also shows whether a trend is in motion or it is reversing. Being a lagging indicator, the moving average does not predict the future trend but confirms when the change is taking place.
The exponential moving average (EMA)
There are a few types of moving average indicators. The exponential moving average (EMA) is one of the most widely used ones. It treats more recent data as more significant than the data from older periods which enables it to respond faster to price action than, for instance, a simple moving average. It is recommended to use the EMA for short timeframes.
Stochastic oscillator is a popular momentum indicator. It shows if the market is overbought or oversold by comparing the closing price of a stock to its price range over another period of time. The value of an oscillator is bounded between 0 and 100. There are such types of stochastic oscillators as Fast Stochastic oscillator and Slow stochastic oscillator. The difference between them is that a fast stochastic oscillator is more sensitive to sudden changes and quicker to react to them.
Relative strength index (RSI)
The RSI is another momentum indicator designed to measure the size and speed of price changes and identify whether the stock is overbought or oversold. Same as stochastic oscillator, this indicator fluctuates between 0 and 100. Referring to the RSI may help traders to determine entry and exit signals.
Moving average convergence divergence (MACD)
Moving average convergence divergence (MACD) is one of the most popular stock trend indicators that uses two moving averages (typically the 12-day and 26-day EMAs) to measure a stock’s momentum and identify its trend. To calculate the MACD analysts subtract the 26-day EMA from the 12-day.
Bollinger bands are a lagging indicator aimed to determine what should be considered as high and low prices of a stock. Bollinger bands are named after American financial analyst John A. Bollinger who developed the indicator and the bands (or price channels) that represent volatility range on the chart. Prices are considered to be high at the upper band and low at the lower band.
To understand the concept of this indicator you will primarily need to understand what retracements are. Retracements are short-term price reversals during an overall trend (upward or downward). They are not treated as an indicator for the larger trend direction. The Fibonacci retracement involves placing two extreme points (a through and a peak) divided by Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%. The indicator helps identify support and resistance, placing stop-loss orders, and setting target prices.
Ichimoku cloud (or Ichimoku Kinko Hyo) involves a few technical indicators that help to define support and resistance levels as well as identify momentum and trend direction. It is aimed to improve the accuracy of a forecast of price movements. The cloud on the chart is formed by two lines. The upward trend is claimed when the price is above the cloud. When the price is below the cloud it indicates a downward trend, If the price is inside the cloud it is trendless or transitioning.
Average directional index (ADX)
The ADX shows the strength of a trend while momentum indicators, such as the negative directional indicator (-DI) and the positive directional indicator (+DI) show if the trend is up or down. The market is believed to be in a trend if the ADX is higher than 20. If the indicator is below 20, the market is considered to be "directionless". Traders use the indicator to filter bad signals given by other indicators.
Standard deviation helps to determine the size of a price move and whether the price will experience more or less volatility by comparing present and past price movements. Typically, performed on a 20-day period.
To make the best of your trading, we recommend you keep in mind the following points when using technical indicators for stocks:
- Learn the pros and cons of every indicator and pick those complementing your strategy.
- Don’t use more than 5 indicators at the same time. Traders usually take into account around 3 indicators to reach accurate conclusions.
- Select indicators that complement but do not repeat each other.
- Choose an indicator that supports a trend determined by another indicator to confirm your strategy.
There are many sorts of indicators that may work out in your favor when making trading decisions. Leading indicators are designed to predict future price moves while lagging indicators give signals after a trend has started. Indicators can help identify trends, momentum, volatility, and volume. The most important stock indicators are the ones that complement your strategy and help you reach your trading goals. So, once you pick indicators that are justified by your objective, take time to master them.
Learn more about market trends by reading our Daily forecasts.