5 essential indicators used in technical analysis

Key takeaways

Technical analysis (TA) indicators help traders understand asset price movements, making it easier to identify patterns and potential trading signals.

Among the many TA indicators available, some of the popular choices include RSI, moving averages, MACD, StochRSI and Bollinger Bands.

While TA indicators can be very useful, the interpretation of their data can be subjective. To reduce risks, many traders use TA indicators in combination with fundamental analysis and other methods.

Introduction

Chart indicators are the weapons of choice for battle-tested technical analysts. Each player will choose tools that best suit their unique play style to then learn how to master their craft. Some like to look at market momentum, while others want to filter out market noise or measure volatility.

But what are the best technical indicators? Well, every dealer will tell you something different. However, there are some very popular ones, such as the ones we have listed below (RSI, MA, MACD, StochRSI and BB). Interested in knowing what it is and how to use it? Read on.

Why Technical Analysis Indicators?

Traders use technical indicators to gain additional insight into the price action of an asset. These indicators make it easier to identify patterns and spot potential buy or sell signals in the current market environment.

There are many types of indicators, and they are widely used by day traders, swing traders and sometimes even longer term investors. There are also professional analysts and advanced traders who create their own custom indicators.

In this article, we provide a brief description of some of the most popular technical analysis (TA) indicators that can be useful in any trader’s market analysis toolkit.

1. Relative Strength Index (RSI)

The RSI is a momentum indicator that shows whether an asset is overbought or oversold. It does this by measuring the magnitude of recent price changes. The default setting is the previous 14 periods (14 days for daily charts, 14 hours for hourly charts, etc.). The data is then displayed as an oscillator that can have a value between 0 and 100.

Since the RSI is a momentum indicator, it shows the rate (momentum) at which the price is changing. This means that if momentum is increasing while the price is rising, the uptrend is strong, i.e. more buyers are entering. Conversely, if momentum is declining while the price is rising, it may indicate that sellers are soon in control of the market.

A traditional interpretation of the RSI is that when it is above 70, the asset is probably overbought, and when it is below 30, it is probably oversold. As such, extreme values ​​can indicate an impending trend reversal or pullback. Still, it may be best not to think of these values ​​as direct buy or sell signals. As with many others technical analysis (TA) techniques, the RSI can provide false or misleading signals, so it is always useful to consider other factors before entering a trade.

Eager to learn more? Check out our article on the Relative Strength Index (RSI).

2. Moving Average (MA)

The purpose of using a moving average in financial charts is to smooth price action and highlight the direction of the market trend. Since they are based on past price data, moving averages are considered lagging indicators.

The two most commonly used moving averages are the simple moving average (SMA or MA) and the exponential moving average (EMA). The SMA is plotted by taking price data from the defined period and producing an average. For example, the 10-day SMA is plotted by calculating the average price over the past 10 days. The EMA, on the other hand, is calculated in a way that gives more weight to recent price data. This makes it more responsive to recent price action.

As mentioned, the moving average is a lagging indicator. The longer the period, the greater the delay. As such, the 200-day SMA will react more slowly to recent price action than the 50-day SMA.

Traders often use the ratio of the price to specific moving averages to measure the current market trend. For example, if the price remains above the 200-day SMA for a long period of time, the asset can be considered a bull market by many merchants.

Traders can also use moving average crossovers as buy or sell signals. For example, if the 100-day SMA crosses below the 200-day SMA, it can be considered a sell signal. But what exactly does this cross mean? This indicates that the average price over the past 100 days is now below that of the past 200 days. The idea behind selling here is that short-term price movements no longer follow the uptrend, so the trend is more likely to reverse soon.

Eager to learn more? Check out our article on moving averages.

3. Moving average convergence divergence (MACD)

The MACD is used to determine the momentum of an asset by showing the relationship between two moving averages. It consists of two lines – the MACD line and the signal line. The MACD line is calculated by subtracting the 26 EMA from the 12 EMA. This is then plotted over the MACD line’s 9 EMA – the signal line. Many charting tools also often include a histogram, which shows the distance between the MACD line and the signal line.

By looking for divergences between the MACD and the price action, traders can gain insight into the strength of the current trend. For example, if the price makes a higher high while the MACD makes a lower high, the market may soon reverse. What does the MACD tell us in this case? That price increases while momentum decreases, so there is a greater likelihood of a pullback or reversal occurring.

Traders can also use this indicator to watch for crossovers between the MACD line and its signal line. For example, if the MACD line crosses above the signal line, it may suggest a buy signal. Conversely, if the MACD line crosses below the signal line, it may indicate a sell signal.

The MACD is often used in combination with the RSI, as they both measure momentum, but through different factors. The assumption is that together they can provide a more complete technical outlook on the market.

Eager to learn more? Check out our article on the MACD.

4. Stochastic RSI (StochRSI)

The Stochastic RSI is a momentum oscillator used to determine whether an asset is overbought or oversold. As the name suggests, it is a derivative of the RSI, as it is generated from RSI values ​​instead of price data. It is created by applying a formula called the Stochastic Oscillator Formula to the regular RSI values. Typically, the Stochastic RSI values ​​range between 0 and 1 (or 0 and 100).

Due to its greater speed and sensitivity, the StochRSI can generate many trading signals that can be difficult to interpret. In general, it tends to be most useful when near the upper or lower extremes of its range.

A StochRSI reading above 0.8 is usually considered overbought, while a value below 0.2 can be considered oversold. A value of 0 means that the RSI is at its lowest value in the measured period (the default setting is typically 14). Conversely, a value of 1 represents that the RSI is at its highest value in the measured period.

Just like how the RSI should be used, an overbought or oversold StochRSI value does not mean that the price will surely reverse. In the case of the StochRSI, it simply indicates that the RSI values ​​(from which StochRSI values ​​are derived) are near the extremes of their recent readings. It is also important to keep in mind that the StochRSI is more sensitive than the RSI indicator, so it tends to generate false or misleading signals more often.

Eager to learn more? Check out our article on the Stochastic RSI.

5. Bollinger Bands (BB)

Bollinger Bands measure the volatility of the market, as well as overbought and oversold conditions. They consist of three lines – an SMA (the middle band), and an upper and lower band. The settings can vary, but typically the upper and lower bands are two standard deviations away from the middle band. As volatility increases and decreases, the distance between the bands also increases and decreases.

In general, the closer the price is to the upper band, the closer to overbought conditions the charted asset may be. Conversely, the closer the price is to the lower band, the closer it may be to oversold conditions. The price will mostly stay within the bands, but on rare occasions it may break above or below them. While this event may not be a trading signal in itself, it can serve as an indicator of extreme market conditions.

Another important concept of BBs is called the squeeze. This refers to a period of low volatility, where all bands come very close together. This can be used as an indicator of potential future volatility. Conversely, if the bands are very far apart, a period of reduced volatility may follow.

Eager to learn more? Check out our article on Bollinger Bands.

Concluding thoughts

Although indicators show data, it is important to consider that the interpretation of that data is very subjective. As such, it’s always helpful to step back and consider whether personal biases are influencing your decision-making. What may be a direct buy or sell signal to one trader may just be market noise to another.

As with most market analysis techniques, indicators are at their best when used in combination with each other or with other methods, such as fundamental analysis (FA). The best way to learn technical analysis (TA) is through a lot of practice.

Further reading

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