Whether you are interested in trading forex, commodities or equities, using technical analysis can be a useful part of your strategy. This includes studying various trading indicators.
Trading indicators are mathematical calculations represented by lines on a price chart that help investors identify certain signals and trends in the market.
There are different types of trading indicators, including leading indicators and waiting indicators.
A leading indicator is a forecast signal that predicts future price movements. While a trailing indicator analyzes past trends and indicates momentum.
You can use your knowledge and risk appetite as a measuring tool to choose which of these indicators best fits your strategy.
The best 10 trading indicators
Please note that the trading indicators listed in this article are not ranked, but some are among the most popular choices among retail investors.
Moving average (MA)
The MM, or simple moving average (SMA), is an indicator used to identify the direction of a current trend without the impact of short-term price spikes.
This type of indicators combines the price points of a financial instrument over a given period and divides them by the number of data points to establish a single trend line.
The data used depends on the duration of the MM. For example, a 200-day MM requires 200 days of data.
Using the MM indicator, you can analyze support and resistance levels and see previous price variations (market history). This means you can also determine potential future trends.
Exponential moving average (EMA)
The EMA is another form of moving average.
Unlike the MMS, it gives greater prominence to recent data points, allowing the data to be more responsive to new information.
When used in conjunction with other indicators, MMEs can help investors confirm important market movements and measure their legitimacy.
The most popular exponential moving averages are the 12- and 26-day MMEs for short-term averages, and the 50- and 200-day MMEs for long-term trend indicators.
The stochastic oscillator
A stochastic oscillator is an indicator that compares the closing price of an asset with different prices over time to indicate momentum and the strength of a trend.
This indicator is expressed on a scale from 0 to 100, with a reading below 20 generally corresponding to an oversold market and a reading above 80 to an overbought market.
However, if there is a strong trend, a correction or rally will not necessarily take place.
Moving average convergence/divergence (MACD)
The MACD is an indicator that detects changes in momentum by comparing two moving averages.
It helps investors identify potential buying and selling opportunities around support and resistance levels.
Convergence” means that two moving averages are converging, while ‘divergence’ means that they are moving away from each other.
If the moving averages converge, momentum weakens, while if they diverge, momentum increases.
Bollinger Bands
A Bollinger band is an indicator that provides a price channel in which an asset generally trades.
The width of the band increases or decreases to reflect volatility.
The closer the bands are to each other (narrower), the lower the perceived volatility of the financial instrument. While the further apart the bands are, the higher the perceived volatility.
Bollinger bands are used to detect when an asset is trading outside its usual levels, and are primarily used to predict long-term price movements.
When prices consistently move above the upper band, the asset may be overbought, and when they move below the lower band, it may be oversold.
Relative Strength Index (RSI)
The RSI is mainly used to help investors identify momentum, market conditions and warning signals of dangerous price movements. The RSI is expressed between 0 and 100.
An asset around the 70 level is often considered overbought. Whereas an asset at or near 30 is often considered oversold.
An overbought signal suggests that short-term gains may be reaching a maturity point, and that assets may be due for a price correction.
On the other hand, an oversold signal could indicate that short-term declines are reaching maturity and that assets could experience a rally.
Fibonacci retracements
Fibonacci retracements are used to identify the amplitude of market corrections and rebounds.
A retracement occurs when the market experiences a temporary decline, also known as a pullback.
Investors who believe the market is about to move often use Fibonacci retracements to confirm this.
Indeed, they help identify potential resistance and support levels that may indicate an upward or downward trend.
Since investors can identify support and resistance levels using this indicator, it helps them determine when to open or close a position, as well as where to place stops and limits.
The Ichimoku cloud
The Ichimoku cloud, like many other technical indicators, identifies support and resistance levels.
However, it also estimates price momentum and provides signals to investors to help them make a decision.
“Ichimoku” means ‘to see the balance in the blink of an eye’, which is why this indicator is used by traders to gain maximum information from a single chart.
In short, it identifies market trends by indicating support and resistance levels, and predicts future levels.
Standard deviation
Standard deviation is an indicator that helps traders measure the amplitude of price variations. It can therefore identify the impact of volatility on future prices. It cannot predict whether prices will rise or fall, but only whether they will be impacted by volatility.
Standard deviation compares current price variations with historical price variations. Many traders believe that large swings follow small swings, and small swings follow large swings.
Average Directional Movement Index (ADX) included in DMI-Directional Movement
The ADX illustrates the strength of a price trend.
It is expressed on a scale from 0 to 100. A figure above 25 is considered a strong trend, while a figure below 25 corresponds to a slippage.
Traders can use this information to determine whether an upward or downward trend is likely to continue.
ADX is generally based on the moving average of a 14-day range, depending on the frequency traders prefer.
Please note that ADX never indicates how a trend will evolve, it only indicates the strength of the trend.
The average directional movement index may rise when a price falls, indicating a strong downtrend.
What you need to know before using trading indicators
The first rule of using trading indicators is never to use any one indicator in isolation, or to use too many at once.
Concentrate on a few of them, the ones you feel are best suited to your objectives. You should also use technical indicators alongside your own analysis of an asset’s price movements over a given period (the “price action”).
It is important to remember that you must confirm a signal in any way you can. If you detect a buy signal from an indicator and a sell signal from price action, you need to use different indicators or different timeframes until your signals are confirmed.
You should also bear in mind that you should never stray from your trading plan.
The rules you have established for your trading must always be applied when using indicators.
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