Technical Indicators: Analyze market data for trading and investing

Technical analysis seeks to identify underlying patterns of buying and selling in a stock or security that can provide clues about potential entry and exit points. This is done using technical indicators – essentially mathematical calculations that analyze historical price and volume data to provide objective buy and sell signals.

Trending indicators

As the name suggests, these technical indicators help identify the direction of a stock’s trend. Multiple trends can exist simultaneously, even sometimes conflicting with each other, so using an indicator that matches your strategy and time frame is key.

Moving Average (MA). A simple moving average is a simple and widely used technical indicator that smooths price trends by calculating average prices over a specific period of time. There are also more complex forms of this indicator, including exponential and weighted moving averages.

Parabolic SAR. Developed by technical analysis pioneer J. Welles Wilder, this trend-following indicator uses a series of trailing dots to highlight potential trend changes on a chart. This can help confirm an existing trend or highlight when a trend is starting to slow.

Average Directional Index (ADX). Also developed by Wilder, this indicator measures the strength of a trend, but not the direction. When the ADX is above 25, it indicates that a strong trend is active; when it is below 20, no trend is present.

Momentum indicators

Momentum indicators measure the strength of a stock’s price movement in one direction over a given period of time and work best in conjunction with trend-following indicators.

MACD (moving average convergence divergence). As mentioned, some technical indicators fall into more than one category. MACD visualizes the relationship between two trend-following moving averages, and shows whether the momentum of the trend is increasing or decreasing. MACD is one of the most powerful indicators out there, but it has a lot of moving parts.

Relative Strength Index (RSI). Another Wilder creation, this momentum oscillator measures the strength of a stock’s price action. This can be used to identify overbought or oversold conditions.

Stochastic oscillator. This indicator compares a stock’s closing price with its price range over a specified period of time. This can help traders identify potential trend reversals.

Volatility indicators

This group of technical indicators helps measure the likelihood of sudden – and often extreme – changes in the price of a stock.

Bollinger Bands. Developed by John Bollinger, this indicator plots two standard deviations away from a moving average, creating “bands” that follow a stock’s highs and lows. This can be used to help identify potential breakouts or trend reversals.

Average True Range (ATR). Also created by Wilder, this technical indicator calculates the average price range of a stock over a specific period of time. The higher the ATR value, the higher the volatility.

CBOE Volatility Index (VIX). Instead of analyzing price, the VIX was created by the Chicago Board Options Exchange to measure the market’s expectation of price movement in the S&P 500 index. It is drawn as a standalone graph.

Volume indicators

Volume represents the total number of shares traded in a stock (or number of contracts, for options and futures) during a given period. Many traders believe that when more volume accompanies a price movement, it is more valid, in a “wisdom-of-the-crowd” kind of way.

On-balance volume (OBV). This technical indicator uses changes in cumulative trading volume to predict changes in stock price. This can help identify specific areas of buying and selling pressure.

Volume-weighted average price (VWAP). An increasingly popular indicator, VWAP calculates the average price at which a stock has traded throughout the day, adjusted for volume. Anchored VWAP is a modified version of this indicator that can be used over any time period.

Support and resistance tools

One of the underlying theories behind technical analysis is that price has “memory,” meaning that the actions of buyers and sellers can create support or resistance at specific price levels. These levels can then be used to refine entry and exit points, as well as manage risk.

Fibonacci. Some support and resistance tools are based on the Fibonacci sequence, which was discovered by the Italian mathematician Leonardo Fibonacci. These indicators include Fibonacci retracements, extensions and channels.

The bottom line

Technical indicators do not guarantee anything – no indicator, whether technical or fundamental, can do that. But these math-based tools can offer clues about where other investors have looked to buy and sell in the past, and where a stock’s movement has tended to pick up steam (up or down). In this way, technical indicators can provide a potential edge for traders and investors looking to select entry and exit points.