Traders who subscribe to technical analysis operate under the fundamental theory that prices move in patterns and that price never lies.
To the inexperienced eye, a stock chart may look like an unpredictable line with a jumble of colors and marks. But these traders are watching charts to pick up on the subtlest of indicators of where share prices could be headed next. Here’s a breakdown of some of the most common indicators technical traders are watching and what they mean.
Identifying trends over different time frames are useful because it can help weed out all the noise of daily volatility. Any type of trend, including uptrends, downtrends, and sideways trends, can be traded for a profit so long as it’s shown itself to be consistent.
Trend traders use a number of different indicators to help them figure out what kind of trend a stock is in. One of the most popular of these indicators is moving averages, which is represented by a single line that represents a stock’s average price over a given time. The 50-day moving average and 200-day moving average are the two most commonly cited.
Other examples of trend indicators include Moving Average Convergence Divergence (MACD), average directional index, parabolic SAR, and linear regression.
Volume, of course, is the measure of the total number of shares that trade in a given time period. Where volume really comes in handy is for confirmation. Many traders use volume to confirm the conclusions from another type of indicator, such as a trend.
Sometimes, market conditions and/or lack of liquidity alone can temporarily drive a stock higher or lower. However, these moves often occur on relatively low volume and can be short-lived. On the other hand, if a stock makes a big move on extremely high volume, that’s a reliable signal that there is major buying and selling going on, and the move should be taken seriously.
Volume indicators include the Money Flow Index, Chaikin Money Flow, on-balance volume, demand index, and force index.
Momentum indicators are like speedometers for traders; they show how fast a stock is moving in a given direction. These indicators are typically displayed as oscillators, which fluctuate above and below a baseline level to indicate how much positive (buying) or negative (selling) momentum a stock is experiencing.
Arguably the most popular of the momentum indicators is the Relative Strength Index or RSI. RSI is represented by a chart that tracks a stock’s price on a scale of 0-100. Most RSI charts have lines at the 30 and 70 mark. If the stock moves above 70, it’s considered overbought, meaning there’s too much buying pressure on the stock and it could fall lower.
If the stock moves below 30, that is a signal that the stock is oversold, and buyers could soon come in and drive the price higher. However, it’s worth noting that RSI can sometimes stay above 70 or below 30 for prolonged periods of time.
Other examples of momentum indicators include stochastics, Commodity Channel Index (CCI), Chande’s momentum oscillator, and Williams %R.
Volatility is a measure of how large a stock’s movement in a given period tends to be. When a stock makes large moves in a short period of time, it is considered to be volatile. Volatility is a very important indicator for traders because volatility makes it easier to profit due to price inefficiencies. Without volatility trading opportunities would be limited.
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