Have you ever wondered when is the right time to enter and exit the market? We bet you have. Well, entering and exiting the market cannot be determined by your daily horoscope. Instead, technical indicators are those functional tools that let you decide when to enter and exit to make the best out of the stock market.
In today’s blog, we will talk about the technical indicators that every trader must know. We will also give you an overview of the best technical analysis app for the Indian stock market.
What are technical indicators?
Technical Indicators are heuristic or pattern-based signals based on the volume, price, and/or open interest of securities or contracts. Traders use technical indicators to assess market psychology and stock supply and demand. Some technical indicators generate signals independently, while others work in conjunction. Technical analysts estimate a security’s strength or weakness by analyzing trading signals, price movements, patterns, and other analytical charting tools.
How do technical indicators work?
Technical analysis of stocks is a trading discipline that is employed for evaluating and identifying trading opportunities by examining statistical trends accumulated from trading activity, such as volume and price movement. In contrast to fundamental analysts, who use financial or economic data to determine a security’s intrinsic value, technical analysts evaluate a security’s strength or weakness by observing patterns of price movements, trading signals, and other charting tools.
Technical analysis is an exquisite trading discipline as it can be used for any security that has historical trading data. This includes stocks, commodities, futures, currencies, fixed-income, and other securities.
The technical indicators also referred to as “technicals,” are based on historical trading data, such as volume, price, and open interest, rather than on the fundamentals of a business like revenue, profit, or profit margins. Active traders commonly use technical indicators to analyze short-term price movements, but long-term investors may also benefit from technical indicators for determining entry and exit points in the market.
What are the types of technical indicators?
Technicals can be divided into:
- Momentum Indicators
- Trend Indicators
- Volume Indicators
- Volatility Indicators
- Breadth Indicators
The momentum indicator provides traders with a tool to determine how quickly or slowly the price of securities changes. These indicators have to be used for other tools and indicators because they identify only the time frame where price changes, not in the direction of movement.
These indicators help traders understand the speed at what speed the prices of certain stocks change. Nonetheless, they are also helpful in understanding the strength of price movements.
At certain times, stock fall rapidly, whereas at other times they fall slowly. Momentum indicators can be helpful in understanding the speed of the rise or fall in particular stocks.
Momentum indicators beneficial in ascertaining the speed of the prices are listed below:
1. Moving Average Convergence Divergence (MACD)
MACD portrays the relationship between two moving averages i.e. 12 EMA and 26 EMA. It consists of the signal line and MACD line. The MACD line is the variation between the two EMAs, the 26 EMA, and the 12 EMA. The signal line is 9 EMA.
When the MACD line traverses the signal line from below, the buying signal is generated, and when the MACD line traverses the signal line from above, the selling signal is generated.
2. Relative Strength Index (RSI)
The RSI acts as a benchmark for price changes as well as the speed at which the price changes for a particular period. The indicator sways between 0 and 100. When traders look for divergences, they can spot the signals, and when the indicator traverses the midline, which is 50.
When RSI crosses over 50 signals uptrend and positive momentum are observed. Though, if it hits 70 and above, then overbought conditions are indicated. If the RSI hits below 50, then it shows a downtrend and negative momentum. If it is below 30, then it indicates oversold conditions.
3. Average Directional Index (ADX)
A Directional Movement System was developed by Welles Wilder based on the Average Directional Index (ADX), the Plus Directional Indicator (+DI), and the Minus Directional Indicator (-DI).
These indicators measure both the direction of price movements and momentum. ADX values of 20 and above indicate that the market is trending, and any reading below 20 indicates that the market is consolidated or “directionless”.
Trend traders enter a long position when the security is trending upward. Contrary to that, trend traders enter a short position when the security is trending downward.
Trend traders grain from trading with the trends. Profits are captured by this trend trading method by analyzing the stock momentum in a particular direction.
Trend indicators help traders in analyzing whether the trends will reverse or continue. Although no sole technical indicator will help gain profits, one also needs trading psychology and well-defined risk management.
1. Moving Averages
The moving average smooths out price data by making averages out of price data constantly. On a price chart, a moving average is denoted by a flat line that decreases variations due to random price fluctuations.
The average can range from 10 days to 30 minutes, whatever the trader chooses. For long-term trend traders, the 50-day, 100-day, and 200-day simple moving averages are popular moving averages.
You can trade with moving averages in the following ways:
a) By analyzing the angle of this indicator, if the moving average is mostly moving horizontally, then the price ranges.
b) An uptrend occurs, when moving average line angles up. However, moving averages only reveal what the price is doing over time and do not predict the future value of the stock.
c) The moving averages can also be analyzed with crossovers. Traders can do this by plotting a 50-day moving average and a 200-day moving average on the chart. When the 50-day moves above the 200-day, then a buy signal occurs. And, when the 50-day drops below the 200-day, then a selling signal occurs.
Supertrend is a market indicator of trending price movement direction. This trend indicator is plotted below or above the closing price. Supertrend changes color based on the change in the trend direction.
If the indicator moves below the closing price, then it turns green and signals a buying position. And, if the indicator closes above, then it turns red and indicates a selling signal.
3. Parabolic SAR
Parabolic SAR accentuates the direction in which the asset is moving. Parabolic SAR looks like dots placed either below or above the price bars on the chart. A bullish signal is indicated by a dot below the price, and a dot above the price indicates that the momentum may remain downward and bears are in control. A potential change in price direction is indicated by dots being reversed.
Traders, especially novice traders, need to pay more attention to the volume indicator, the most critical technical indicator. Volume plays a crucial role in confirming patterns and trends. Volume indicators also indicate how many stocks were sold and bought at a given period in the stock market.
We can use volume to determine when a price trend will continue or reverse because it leads to the price movement of the stock. Therefore, volume indicators are essential indicators for a trader.
1. On-balance Indicator
OBV or On-balance Volume calculates the selling and buying pressure as a cumulative indicator that sums up the volume on up days and subtracts on down days. All of the day’s volume is considered up-volume when the stock closes higher than on the previous day’s. Similarly, all of the day’s volume is considered down-volume when the stock closes lower than on the previous day’s. One should focus on the direction rather than the value.
- When OBV as well as the prices are making higher troughs and higher peaks, the upward trend is expected to continue.
- When OBV as well as the prices are making lower troughs and lower peaks, the downward trend is expected to continue.
- When prices continue to make higher peaks but OBV makes lower peaks, then the upward trend is probably going to fail.
- When prices continue to make lower troughs but OBV makes higher troughs, the downward trend is likely to fail.
- When the security’s price closes up on a particular day, the day’s volume is added to a cumulative total, and when it closes down, it is subtracted from the day’s volume.
2. Trader’s Lion Enhanced Volume
- High Relative Volume Bars: When analyzing your Daily & Weekly Charts, highlight high relative volume bars and high closing ranges in lime green for the best volume interpretation possible.
- Low Relative Volume Bars: On your Daily and Weekly Charts, use a down arrow for labeling low relative volume days for interpreting constructive volume and price action.
- Volume Labels: High volume days are marked to show two things: the percentage above the average and the total number of shares traded.
- Highest Volume in Over a Year: Check for “HV” on the brow of the volume bar, to identify this potent characteristic.
- Simple Moving Average: For saving indicator slots, use SMA overlay on volume.
- High Relative Volume Alerts: Configure alerts that are triggered when a high relative volume threshold is reached.
3. Volume Price Trend Indicator
VPT or Volume Price Trend indicator helps in ascertaining the stock’s price direction and also the price change strength. By adding or subtracting a multiple of a share price’s trend and volume, the cumulative volume line calculates the percentage change in a share price’s trend over time.
Interpretation of the VPT can be summed up as:
- An increase in volume and price indicate an upward price trend.
- A decrease in volume and price indicate a downward price trend.
- A negative divergence indicates that the downward price movement is feeble and may reverse if there is an inflation in price accompanied by a flat or decreasing volume trend.
- A positive divergence indicates that the upward price movement is feeble and may reverse if there is a deflation in price accompanied by a flat or increasing volume trend.
A trending or consolidated market should not be the only factor while trading in the stock market. Volatility is also essential. Volatility helps traders trade more efficiently. Volatile periods can create significant swings that can make trading in the market difficult for traders.
1. Bollinger Bands
Bollinger bands contain 3 bands: middle, lower and upper bands. The middle band denotes bars moving average or 20 days, the lower band is -2 standard deviation, and the upper band is +2 standard deviation of the middle band.
When volatility increases, the bands expand, and when volatility decreases, the band contract. The Bollinger bands can be used to trade when prices break out from either side of the upper or lower bands following a low volatility or consolidation phase.
2. Keltner Channel
This indicator is placed on either side of the stock’s price and helps in determining the trend direction. As the Keltner channel identifies trend continuation by breaking both above and below the top and bottom barriers, it uses the average-true range (ATR).
The middle line indicates EMA or Exponential Moving Average. The upper band is generally set two times the ATR greater than the EMA, and the lower band is generally set two times the ATR lower than the EMA. These bands contract and expand as Volatility is measured by ATR contracts and expands.
The market breadth denotes the participants in the stock market. Using breadth, you can determine how many stocks are participating in a rally. From breadth, we can also estimate the number of active investors.
1. Percentage / Number of Stocks above Moving Average
By measuring the percentage of stocks trading above a specified moving average, a breadth indicator gauges the underlying index’s internal strength or weakness. Medium-to-long-term timescales are covered by 150-day and 200-day moving averages and short-to-medium-term timescales are covered by 50-day moving averages.
Oversold/ overbought levels, crossover below/above 50%, and bearish/bullish divergences can be used to generate signals. A bullish bias is exhibited when the indicator is exceeding 50%. This indicates that the index contains more than half of the stocks that are above a particular moving average. A bearish bias is present when the indicator is below 50%.
2. Periodic Highs and Lows
Periodic highs and lows are the high and low levels in a specified period. Users can check the number of stocks trading around their periodic low or high for various periods. A period high/low analysis is applicable to securities that trade within 20% of their High/Low range.
What is the best technical analysis tools for Indian traders?
Technical Indicators are an important component to help the users scan the best stocks and make higher profits and informed decisions. By analyzing and studying the patterns minutely, you can decide on your entry and exit actions and pave the path to gaining profits. Moreover, these indicators can be also incorporated into automatic trading systems. With a plethora of different options, traders must select the best indicators and can become familiar with how they operate.
Hope this blog was helpful in giving you a productive insight into technical indicators. To trade effectively, traders should create a trading setup with 2-3 technical indicators. A trader’s trading setup determines which indicators are appropriate to use.