Using technical analysis to research stocks is a common strategy to profit from short-term movements in security prices. While some stock analysis tools are fundamental in nature, technical stock indicators typically seek patterns in past price and volume data to give investors and traders insights about how a stock might move in the future.
Naturally, every stock indicator has its pros and cons. Technical indicators can be used by traders to analyze supply and demand forces on stock price, to help investors to understand market psychology, or to manage risk. But while stock indicators and trading tools can help with buy and sell points, false signals can also occur.
For that reason, although technical indicators can assist with trend identification, it’s best to combine different indicators when conducting your stock analysis.
Learn more about the pros and cons of using the following 15 trading tools in your strategy.
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How Do Stock Technical Indicators Work?
Technical analysis uses various sets of data and indicators, such as price and volume, to identify patterns and trends. It does not use fundamental analysis to look at the underlying companies, their industries, or any macroeconomic trends that might drive their success or failure.
Rather, technical analysis solely analyzes a stock’s performance. Technical indicators are often rendered as a pattern that can overlay a stock’s price chart to predict the market trend, and whether the stock would be considered “overbought” or “oversold.”
One of the basic tenets of technical analysis is that history tends to repeat itself. By examining certain patterns in light of past outcomes, analysts can make an educated guess about where stock prices might be headed. That said, past performance is never a guarantee of future stock price movements, so traders must bear this in mind.
Knowing many of the most popular trading tools might benefit your investing strategy with easier to spot buy and sell signals. You don’t have to know every single technical indicator, and there are many ways to analyze stocks, but using multiple stock indicators may improve trading results. You can also use these stock indicators to help you manage risk when you are actively trading.
Trend indicators are some of the most important technical trading tools since identifying a security price’s trend is often a first step to forming a strategy. Long positions are often initiated during uptrends, while short sale ideas can occur when prices are in an established downtrend.
Volume technical indicators are also helpful to gauge the power or conviction of an asset’s price move. Some believe that the higher the stock volume on a bullish breakout or bearish breakdown, the more confident the move is. Higher volume could signal a lengthier trend continuation.
Two Types of Technical Indicators
Technical indicators generally come in two flavors: overlay indicators and oscillators.
An overlay indicator typically overlays one trend onto another on a stock chart, often using different colors to distinguish between the lines.
On a technical analysis chart, an oscillator tracks the distance between two points in order to gauge momentum. The moving average is a common oscillator; it’s considered a lagging indicator as it measures specific intervals in the past.
An oscillator indicator can help traders determine support and resistance in certain price trends, so they can decide whether to sell or buy.
Oscillator indicators can be leading or lagging:
• A leading indicator tracks current market movements to anticipate where the trend is headed next.
• A lagging indicator is based on recent history and seeks patterns that will indicate potential price movements.
Top 15 Stock Indicators for Technical Analysis
It’s important to remember that these trading tools were developed based on the belief that mathematically derived patterns may be valuable as predictors of stock movements. Past performance, however, is not a guarantee of future results. So while it can be useful to employ stock technical indicators, they are best used in combination before deciding on a potential trade.
Also, many of these trading tools are lagging indicators, which can lead to an inaccurate reflection of current and future market conditions.
Following are 15 of the most common technical stock indicators, along with their advantages and disadvantages.
- Moving Averages (MA)
- Moving Average Convergence Divergence (MACD)
- Relative Strength Index (RSI)
- Stochastic Oscillator
- Williams %R
- Bollinger Bands
- On-Balance Volume (OBV)
- Accumulation / Distribution Line (ADL)
- Average Directional Index (ADX)
- Price Relative / Relative Strength
- Relative Volume (RVOL)
- Rate of Change (ROC) and Momentum
- Standard Deviation
- Ichimoku Cloud
- Fibonacci Retracements
1. Moving Averages (MA)
A moving average (MA) is the average value of a security over a given time. The MA can be Simple Moving Average (SMA), Exponential Moving Average (EMA), and Weighted Moving Average (WMA).
A moving average smooths price volatility and is taken as an indicator of the direction a price may be headed. If the price is above the moving average, it’s considered an uptrend versus when the price moves below the MA, which can signal a downtrend. Moving averages are typically used in combination with each other, or other stock indicators, to identify trends.
• Using moving averages can filter out the noise that comes from price fluctuations and focus on the overall trend.
• Moving average crossovers are commonly used to pinpoint trend changes.
• You can customize moving average periods: common time frames include 20-day, 30-day, 50-day, 100-day, 200-day.
• A simple moving average may not help some traders as much as an exponential moving average (EMA), which puts more weight on recent price changes.
• Market turbulence can make the MA less informative.
• Moving averages can be simple, exponential, or weighted, which might be confusing to new traders.
2. Moving Average Convergence Divergence (MACD)
The Moving Average Convergence Divergence (MACD) also helps investors gauge whether a security’s movement is bullish or bearish, but it uses two different MAs to do so. Often, a 26-period exponential moving average is subtracted from a 12-period EMA to spot trading signals. Then a signal line, based on a shorter period EMA, is plotted on top of the MACD to help reveal buy and sell entry points.
Traders use the convergence or divergence of these lines to identify when bullish or bearish momentum is high.
• The MACD, used in combination with the relative strength index (below) can help identify overbought or oversold conditions.
• The MACD can be used to indicate a trend and also momentum.
• Can help spot reversals.
• May provide false reversal signals.
• Responds mainly to the speed of price movements; less accurate in gauging the direction of a trend.
3. Relative Strength Index (RSI)
RSI is a tool that identifies bullish vs. bearish price momentum. The relative strength index is an oscillator — a tool that builds a trend indicator based on the price movement between two extreme values. It ranges from 0 to 100. Generally, above 70 is considered overbought and under 30 is thought to be oversold.
• Can help investors spot buy or sell signals.
• May also help detect bull market or bear market trends.
• Can be combined with moving average indicators to spot breakout trends or reversals.
• The RSI can move without exhibiting a clear trend.
• The RSI can remain at an overbought or oversold level for a long time, making this tool less useful.
• It does not give clues as to volume trends.
4. Stochastic Oscillator
The stochastic oscillator has two moving lines, or stochastics, that oscillate between and around two horizontal lines: The primary “fast” moving line is called the %K, while the other “slow” line is a three-period moving average of the %K line.
A signal is generated when the “fast” %K line diverges above the “slow” line or vice versa. The stochastic oscillator uses a 0 to 100 value range.The two horizontal lines are often pre-set at 30 and 70, indicating oversold and overbought levels, respectively, but can be modified.
• Since it’s plotted on a 0 to 100 scale, it’s possible to gauge overbought and oversold levels.
• Traders can adjust time frame and range of prices to reduce market fluctuation sensitivity.
• Can be used by day traders.
• A security can remain overbought or oversold for long periods as the range of oscillations is not always proportionate to a security’s price action.
• It can be useful for implementing an overall strategy, but not for gauging the overall market sentiment or trend direction.
5. Williams %R
Similar to the stochastic oscillator, above, the Williams %R (a.k.a. the Williams Percent Range) is also a momentum indicator — but in this case it moves between 0 and -100 to identify overbought and oversold levels and find entry and exit points in the market. The Williams %R compares a stock’s closing price to the high-low range over a specific period, typically 14 days.
Readings between 0 and -20, which are in the top 20% of price during the look-back period, are considered overbought. Readings between -80 and -100, which are in the lowest 20% of price during the look-back, are considered to be oversold.
• You can combine different short and long time periods to compare trends.
• Identifies overbought and oversold levels.
• False signals can happen if price strength or weakness leads to a brief movement in the Williams %R above 70% or below 30%.
• There is no volume analysis with the Williams %R.
6. Bollinger Bands
Bollinger Bands are a set of three lines that help measure the relative high or low of a security’s price in relation to previous trades. The center line is the Simple Moving Average (SMA) of the stock price. The other two trendlines are plotted two standard deviations away from the SMA (one positively, one negatively). These can be adjusted.
The upper and lower lines show the high and low boundaries of the security’s expected price movement (90% of the time). The middle line shows real-time price action moving between those bounds as it fluctuates day-to-day.
• Helps traders identify volatility.
• Can help point to trading opportunities.
• Large losses are possible when volatility surges unexpectedly.
• Does not identify cycle turns quickly enough at times.
7. On-Balance Volume (OBV)
OBV is a little different from the other indicators mentioned. It primarily uses volume flow to gauge future price action on a security or market. When there’s a new OBV peak, it generally indicates that buyers are strong, sellers are weak, and the price of the security will likely increase. Similarly, a new OBV low is taken to mean that sellers are strong and buyers are weak, and the price is trending down.
The numerical value of the OBV isn’t important — it’s the direction that matters. Declining volume tends to indicate declining momentum and price weakness, while increasing volume tends to indicate rising momentum and price strength.
• Volume-based indicator gauges market sentiment to predict a bullish or bearish outcome.
• OBV can be used to confirm price action and identify divergences.
• Hard to find definitive buy and sell price levels.
• False signals can happen when divergences and confirmations fail.
• Volume surges can distort the indicator for short-term traders.
8. Accumulation / Distribution Line (ADL)
The ADL is a momentum indicator that traders use to detect tops and bottoms and thus predict reversales. It does this by using volume versus price data to identify divergences and thereby show how strong a trend might be. For example: If the price rises but the ADL indicator is falling, then the accumulation volume may not actually support a true price increase and a decline could follow.
• Traders can use the AD Line to spot divergences in price compared with volume that can confirm price trends or signal reversals.
• The ADL can be used as an indicator of the flow of cash in the market.
• Doesn’t capture trading gaps or factor in their impact.
• Smaller changes in volume are hard to detect.
9. Average Directional Index (ADX)
The Average Directional Index (ADX) also helps investors spot asset price trends and to quantify the strength of those trends. ADX shows an average of price range values that indicate expansion or contraction of prices over time — typically 14 days, but it may be calculated for shorter or longer periods. Shorter periods may respond quicker to pricing movements but may also have more false signals. Longer periods tend to generate fewer false signals but may cause the indicator to lag the market.
The ADX uses positive and negative Directional Movement Indicators (DMI+ and DMI-). ADX is calculated as the sum of the differences between DMI+ and DMI- over time. These three indicators are often charted together.
• Can help identify when price breakouts reflect a solid trend.
• Can send signals to traders to watch the price and manage risk (e.g. thru divergences).
• Can generate false signals if used to analyze shorter periods.
• Can’t be used as a standalone indicator.
10. Price Relative / Relative Strength
Relative Strength should not be confused with the Relative Strength Index (above). Relative Strength is more of an investment strategy than a specific indicator. It involves comparing one asset to another or the broader market and helps traders find securities that are trending on a relative, not absolute, basis.
• A stock indicator that helps compare one security’s price to another to find which is outperforming.
• Can plot one stock versus a competitor or market benchmark.
• Does not provide exact buy and sell levels.
• False breakouts and breakdowns can happen.
• Mean reversion can lead to losses for momentum traders.
11. Relative Volume (RVOL)
RVOL relays to traders how near-term volume compares to historical volume. The higher RVOL is, the more other traders might be paying attention to and trading the asset. Think of it as the stock being “in play.” Stocks that have a lot of volume have more liquidity and tend to trade better than stocks with low relative volume. The RVOL is displayed as a ratio.
So if it is showing 2.5 relative volume, that means it is trading at 3.5 times its normal volume for that time period.
• Can offer clues to identify unusually powerful price moves.
• High and low volume is easily detected by use of being above or below a value of one (1).
• While volume is important, it does not give exact buy and sell price levels.
• Volume surges can be fickle — like around an earnings date.
12. Rate of Change (ROC) and Momentum
ROC is just what it sounds like — the speed at which a stock is moving compared to its trend. The indicator measures a stock’s percentage price change compared to how it moved in recent periods. Like many of the tools mentioned, it can be used to spot divergences.
• Works better in trending markets.
• When used with other trading tools can help traders spot strong momentum.
• A technical trading tool that can identify overbought and oversold levels.
• Ideal for spotting divergences.
• False signals can happen when the indicator suggests a price trend reversal will take place.
• Does not give higher weight to more recent price action.
13. Standard Deviation
An asset’s standard deviation is a fundamental statistical tool to get a sense of volatility. It uses historical volatility to arrive at a percentage that is used to reflect how much a security moves. While volatility can indicate potential risk, it can also signal the potential for opportunity.
• Mathematically captures the volatility of a stock’s movements, i.e. how far the prices moves from the mean.
• Provides technicians with an estimate for expected price movements.
• Can be used to measure expected risk and return.
• Does not provide precise buy and sell signals.
• Must be used in conjunction with other indicators.
14. Ichimoku Cloud
Ichimoku clouds are used to show support and resistance areas on a price chart in an extra-illustrative manner. An Ichimoku Cloud is comprised of five separate calculations that examine multiple averages, and uses the difference between two of the lines to create a shaded area (the cloud) that aims to predict support and resistance levels. It is also employed to identify momentum and trend. It is thought to provide more data than a simple candlestick chart.
• A leading indicator of price.
• Indicates support and resistance areas.
• Useful for gauging the direction and intensity of a price trend.
• Can give many false signals in trendless markets.
• Can be confusing to traders given its complexity.
15. Fibonacci Retracements
Fibonacci Retracements are based on the golden ratio discovered by mathematician Leonardo Pisano in the 13th century. At its core, a Fibonacci retracement is a mathematical measurement of a particular pattern. The Fibonacci sequence and ratio are used to form support and resistance lines on a price chart.
• Offers clues about where a stock might find support and resistance.
• Helps define exit and entry levels.
• Can be used to place stop-loss orders.
• The use is subjective.
• Some say Fibonacci Retracements are simply a self-fulfilling prophecy: if many traders are using these ratios, then outcomes will reflect this.
• No logical proof of why it should work.
Technical analysts use past price and volume data to help traders identify price trends and make buy and sell decisions. It’s important to know that technical analysis does not use fundamentals to assess the underlying companies, their industries, or any macroeconomic trends that might drive their success or failure. Rather, technical analysis solely analyzes a stock’s performance.
Technical indicators are often rendered as a pattern that can overlay a stock’s price chart to predict the market trend, and whether the stock would be considered “overbought” or “oversold.” There are countless stock technical indicators in existence, and it can quickly become overwhelming to learn them all. It might be more useful to focus on a handful of the most popular trading tools so you can execute a strategy that works for you.
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