Trading over short-term market cycles can be extremely challenging, especially in a volatile market. Fortunately, technical indicators serve as reliable guideposts that help predict possible future price movements so that you can decide your entry and exit strategies accordingly.
Technical indicators are widely used in the technical analysis of stocks and securities. In this article, we explore the meaning, types, and common examples of technical indicators.
What is a technical indicator
A technical indicator is a mathematical or pattern-oriented measure or signal that is computed or plotted on a chart. It is based on different metrics like the price, volume data, open interest, and other information pertaining to securities like equity stocks, options contracts or currencies.
Technical indicators are calculated or plotted using historical data. You can then interpret them based on predetermined rules and predict how the price of a stock or security may move in the near term.
How do technical indicators work
Technical indicators work by analysing historical data regarding prices, open interest, and volume. These data points are expressed as numbers or plotted on price charts (or both). Traders can then analyse these signals, interpret them based on predetermined guidelines, and get a clear picture of how the price of a stock or security may move over the short term.
That said, technical indicators alone cannot provide a reliable or guaranteed indication of potential price movements. This is because they rely on historical data — and past performance is never a guaranteed indicator of future earnings. So, to improve the accuracy of your price projections, you can combine technical indicators with candlestick charts and other assessment tools.
Categories of technical indicators
Based on how they are calculated and used to analyse price or volume patterns, technical indicators can belong to any one of the following two categories.
- Oscillators:
As the name indicates, oscillators are technical indicators whose values can swing between a local low and high point. These indicators are typically plotted below or above the price lines in a graphical chart. Some commonly used technical indicators that belong to this category include Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI), and stochastic oscillator. - Overlays:
Overlays are thus called because of how they are plotted on a price chart in technical analysis. These technical indicators are overlaid on a price chart and depicted at the same scale as the prices of the securities being analysed. Some types of technical indicators that are overlays include moving averages, support and resistance lines, and Bollinger Bands.
Commonly used technical indicators
If you are a trader with a short-term market outlook, you need to know what the common technical indicators are and how they can be used to interpret price movements. Here are some technical indicators you may typically come across when you perform technical analysis.
- Support and resistance
Support and resistance levels are technical indicators used to determine price direction and predict breakouts. The support level is determined by the demand for a particular security. It is the level below which the price refuses to fall as long as it is sustained by the demand. The resistance level, on the other hand, depends on the supply or sale of a specific security in the market. It is the level above which the price cannot rise unless the demand exceeds the supply. - Moving Average Convergence Divergence (MACD)
The MACD is a technical indicator that can help you decide your entry and exit points. It is calculated as the difference between these Exponential Moving Averages (EMA): the 12-period EMA and the 26-period EMA. The MACD line is then drawn on the price chart along with the signal line, which is the 9-day EMA. If the MACD line crosses the signal line from below, it signals a possible downtrend (and vice versa). - Bollinger Bands
This is a technical indicator that can help you study market volatility and identify oversold or overbought conditions. The indicator consists of three bands, namely the SMA band (or the middle band), an upper band, and a lower band. Narrow bands indicate low volatility, while wide bands mean the volatility is high. Also, if the price moves below the lower band, it may indicate an oversold condition. If it moves above the upper band, the stock could be overbought. - Relative Strength Index (RSI)
The RSI is a technical indicator that is pivotal for momentum traders. Its values can fluctuate between 0 and 100, and it measures how quickly and strongly the price of a security has changed. You can use the RSI to check if a security is overbought or oversold. RSI values below 30 indicate that the security is possibly oversold, while values above 70 signal that the security may be overbought. Depending on the RSI value, you can take a long or short position. - Average Direction Index (ADX)
The ADX is one of the few technical indicators that you can use to check the strength of a trend. Once you have predicted the direction using other indicators, ensure that you evaluate the average direction index. Like the RSI, the ADX also ranges from 0 to 100. The value of the ADX indicates how strong or weak a trend is. Here is what the values mean:
Value of ADX |
Strength of the Trend |
0 to 25 |
None or weak |
25 to 50 |
Moderate to strong |
50 to 75 |
Very strong |
75 to 100 |
Extremely strong |
- On-Balance-Volume (OBV)
This technical indicator relies on trading volume to analyse security prices. It measures the pressure from sellers and buyers in the market and uses this information to predict if the price may move upward or downward. Rather than the value of the OBV, its direction is more important. A rising OBV accompanied by rising prices indicates a strong upward trend (and vice versa).
Conclusion
This sums up what technical indicators are and how you can interpret some of the common metrics used to analyse stock prices or volumes. To improve your ability to read and use such indicators in real market scenarios, you can practise reading them via simulators or demo accounts before risking your capital.
