7 Technical Indicators to Build a Trading Toolkit

Technical indicators are used by traders to gain insight into the supply and demand of securities and market psychology. Together, these indicators form the basis of technical analysis. Metrics, such as trading volume, provide clues as to whether a price movement will continue. In this way, indicators can be used to generate buy and sell signals.

Seven of the best indicators for day trading are:

On-balance volume (OBV) Accumulation/diffusion (A/D) line Average Directional Index Aroon Oscillator Moving Average Convergence Divergence (MACD) Relative Strength Index (RSI) Stochastic Oscillator

You don’t have to use all of them, instead choose a few that you find useful to make better trading decisions. Learn more about how these indicators work and how they can help you trade successfully.

Tools of the trade

The tools of the trade for day traders and technical analysts consist of charting tools that generate signals to buy or sell, or that indicate trends or patterns in the market. Broadly speaking, there are two basic types of technical indicators:

Overlays: Technical indicators that use the same scale as prices are plotted on top of the prices on a stock chart. Examples include moving averages and Bollinger Bands® or Fibonacci lines. Oscillators: Rather than being plotted on a price chart, technical indicators that oscillate between a local minimum and maximum are plotted above or below a price chart. Examples include the stochastic oscillator, MACD or RSI. It will be mainly this second type of technical indicators that we consider in this article.

Traders often use several different technical indicators in tandem when analyzing a security. With literally thousands of different options, traders must choose the indicators that work best for them and familiarize themselves with how they work.

They may also combine technical indicators with more subjective forms of technical analysis, such as looking at chart patterns, to come up with trading ideas. Technical indicators can also be incorporated into automated trading systems given their quantitative nature.

1. Unbalanced Volume

Use the on-balance volume to measure the positive and negative flow of volume in a security over time. The indicator is a running total of up volume minus down volume. On volume is how much volume there is on a day when the price is rising. Downward volume is the volume on a day when the price is falling. Each day volume is added or subtracted from the indicator based on whether the price went higher or lower.

When OBV rises, it shows that buyers will step in and push the price higher. When OBV falls, selling volume exceeds buying volume, indicating lower prices. In this way it acts as a trend confirmation tool. If price and OBV rise, it helps to indicate a continuation of the trend.

Traders using OBV also look for divergence. This occurs when the indicator and price go in different directions. If the price is rising but OBV is falling, this may indicate that the trend is not supported by strong buyers and may reverse soon.

2. Accumulation/Distribution Line

One of the most commonly used indicators to determine the flow of money into and out of a security is the accumulation/spread line.

Similar to OBV, this indicator also accounts for the trading range for the period and where the close is relative to that range, in addition to the closing price of the security for the period. If a stock closes near its high, the indicator gives volume more weight than if it closes near the midpoint of its range. The different calculations mean that OBV will work better in some cases and A/D will work better in others.

If the indicator line is trending upwards, it shows buying interest as the stock closes above the mid-point of the range. This helps confirm an uptrend. On the other hand, if A/D is falling, it means that the price is ending up in the lower part of its daily range, and thus volume is considered negative. This helps confirm a downtrend.

Traders using the A/D line also look for divergence. If the A/D starts to fall while the price is rising, it indicates that the trend is in trouble and may reverse. Similarly, if the price trends lower and A/D starts to rise, this may indicate higher prices.

3. Mean direction index

The Average Directional Index is a trend indicator used to measure the strength and momentum of a trend. When the ADX is above 40, the trend is considered to have a lot of directional strength, either up or down depending on the direction the price is moving.

When the ADX indicator is below 20, the trend is considered weak or non-trending.

The ADX is the main line on the indicator, usually colored black. There are two additional lines that can optionally be shown. These are DI+ and DI-. These lines are often colored red and green respectively. All three lines work together to show the direction of the trend as well as the momentum of the trend.

ADX above 20 and DI+ above DI-. This is an uptrend.ADX above 20 and DI- above DI+. This is a downward trend. ADX below 20 is a weak trend or fluctuating period, which is often associated with the DI- and DI+ crossing each other quickly.

4. Aroon indicator

The Aroon Oscillator is a technical indicator used to measure whether a security is in a trend, and more specifically if the price hits new highs or lows over the calculation period – typically 25.

The indicator can also be used to identify when a new trend is set to begin. The Aroon indicator consists of two lines: an Aroon Up line and an Aroon Down line.

When the Aroon Up crosses above the Aroon Down, it is the first sign of a possible trend change. If the Aroon Up hits 100 and stays relatively close to that level while the Aroon Down stays close to zero, this is positive confirmation of an uptrend.

The opposite is also true. If Aroon Down crosses above Aroon Up and stays near 100, it indicates that the downtrend is in force.

5. MACD

The moving average convergence divergence indicator helps traders see the trend direction, as well as the momentum of that trend. It also offers a number of trading signals. When the MACD is above zero, the price is in an uptrend. If the MACD is below zero, it has entered a bearish period.

The indicator consists of two lines: the MACD line and a signal line, which moves more slowly. When MACD crosses below the signal line, it indicates that the price is falling. When the MACD line crosses above the signal line, the price rises.

See which side of zero the indicator is on tools to determine which signals to follow. For example, if the indicator is above zero, look for the MACD to cross above the signal line to buy. If the MACD is below zero, the MACD crossing below the signal line can provide the signal for a possible short trade.

6. Relative strength index

The relative strength index has at least three main uses. The indicator moves between zero and 100, and plots recent price gains versus recent price losses. Thus, the RSI levels help to measure momentum and trend strength.

The most basic use of an RSI is as an overbought and oversold indicator. When the RSI moves above 70, the asset is considered overbought and may fall. When the RSI is below 30, the asset is oversold and may rise. However, it is dangerous to make this assumption; therefore, some traders wait for the indicator to rise above 70 and then drop below before selling, or drop below 30 and then rise back above before buying.

Divergence is another use of the RSI. When the indicator moves in a different direction from the price, it shows that the current price trend is weakening and may reverse soon.

A third use for the RSI is support and resistance levels. During uptrends, a stock will often hold above the 30 level and frequently reach 70 or higher. When a stock is in a downtrend, the RSI will typically stay below 70 and frequently reach 30 or below.

7. Stochastic oscillator

The stochastic oscillator measures the current price relative to the price range over a number of time periods. Created between zero and 100, the idea is that the price should make new highs when the trend is up. In a downtrend, the price tends to make new lows. The stochastic track of whether it happens.

The stochastic moves up and down relatively quickly, as it is rare for the price to make continuous highs, keeping the stochastic near 100, or continuous lows, keeping the stochastic near zero. Therefore, the stochastic is often used as an overbought and oversold indicator. Values ​​above 80 are considered overbought, while levels below 20 are considered oversold.

Consider the overall price trend when using overbought and oversold levels. For example, during an uptrend, when the indicator drops below 20 and rises above it again, this is a possible buy signal. But rallies above 80 are less consequential because we expect to see the indicator regularly move to 80 and above during an uptrend. During a downtrend, watch for the indicator to move above 80 and then drop back below to indicate a possible short trade. The 20 level is less significant in a downtrend.

The Bottom Line

The goal of every short-term trader is to determine the direction of a given asset’s momentum and to try to profit from it. There are hundreds of technical indicators and oscillators developed for this specific purpose, and this article has provided a handful that you can start trying out. Use the indicators to develop new strategies or consider incorporating them into your current strategies. To determine which to use, try them in a demo account. Choose the ones you like the most, and leave the rest.