The Top 5 Effective Technical Indicators

The Top 5 Effective Technical Indicators

This is a guest post by Avinash Mittal @Pure_Financial  

There is a close relationship between technical analysis and technical indicators. If technical analysis is an art and a science for trading the stock market and following price trends. Technical indicators help technical analysts react to any significant price action or volatility as it occurs in a stock’s price.

Technical analysis has universal applicability and can be applied to any financial instrument like stocks, forex, fixed-income securities, futures, and commodities, etc. With technical analysis, traders can determine the support and resistance levels in price. Technical analysis can tell you whether the price of a stock has dropped lower or has climbed higher to break out of a previous price range. Technical indicators help traders measure the potential velocity and magnitude of directional price movements.

With technical analysis and technical indicators, traders can project prices and enter an undervalued security at the right time and with the right position size.

Here are five technical indicators you should know as a stock trader, especially if you have not joined any online day trading courses.

1. Relative Strength Indicator

Relative Strength Indicator, popularly known as RSI, is a momentum (the rate of the rise or fall in price) oscillator. It compares the magnitude of recent gains and losses over a specified period for measuring speed and change of price movements of security.

Traders use RSI to recognize overbought or oversold conditions in the trading of an asset. RSI has an upper and lower line. 70 is the upper line, and 30 is the lower line. There is also a dashed mid-line, which is at 50.

Overbought – Price moves up very rapidly, at some point. In it, the RSI crosses 70.

Oversold – Price falls very rapidly, at some point. In It, RSI crosses 30.

RSI is among the most reliable indicators to determine accumulation and distribution phases. It gauges the strength of the ongoing trend.

2. Moving Averages

Moving averages are one of the oldest and most popular technical indicators used by active traders in technical analysis. It is an average of past prices. It creates a single flowing line and smooths price data.
There are three types of moving averages.

Simple moving average (SMA) – It is the simple average of a security over a defined number of time periods.

Exponential moving average (EMA) – It gives greater weight to more recent prices.

Weighted moving average (WMA) – It assigns a heavier weighting to more current data points

When it comes to stocks, 10 days, 21 days, 50 days, 100 days and 200 days are the common time periods for moving average. The simple moving average (SMA) is the most commonly used moving average. In technical analysis it is used to identify a trend.

3. Average Directional Index

Also known as ADX, Average Directional Index gauges the strength of the trend. It is expressed as a single line with values, ranging from 0-100. With ADX, investors can evaluate the most robust area and make the best use of the opportunity for building aggressive positions.

Increasing ADX value above 20 means the trend is getting stronger. On the other hand, a move above 50 generally is the indication of the breakdown of the move. Overall, Average Directional Index is a useful tool to navigate in a trending market.

4. Stochastic Oscillator

The Stochastic Oscillator is another important technical indicator used by technical analysts. It is one of the most reliable momentum tools that help traders in measuring the current momentum – especially when compared to the highs and lows of  a historical set of prices in the form of resistance and support levels.

The concept behind the Stochastic Oscillator is that prices tend to close near their high in an upward-trending market, and they tend to close near their low during a downward-trending market.

When the closing levels are consistently near the top of the range, it indicates accumulation, i.e., buying pressure whereas when the closing levels are near the bottom of the range, it indicates distribution, i.e., selling pressure.

5. Relative Rotation Graphs

Relative Rotation Graphs (RRGs) are popular as a tool for visualization for relative strength analysis. It enables technicians to analyze the relative strength of various securities against a standard benchmark and against each other. With RRGs, technical analysts have the ability to plot relative performance on one and show true rotation. They can identify relative outperformers in any market situation and trade in the sectors of the market that are trending.

RRGs help traders to position their portfolios mix and trade in securities which are likely to see strong trends.

Final Words

These are the five most common and reliable technical indicators traders should know. However, you can only reap the benefits when you are able to use them the right way. Just because these are good indicators doesn’t mean they will give you exact signals in every trade. Technical indicators are tools that have to be incorporated inside a trading system that gives consistent signals for execution with good risk/reward ratios. You can spend up your leaning curve through trading books, and trading eCourses. and online education resources by experienced traders. 

Avinash Mittal has 3 years of experience of stock trading. He likes to write about  stories of stock trading, day trading and supply and demand trading, and overall effectiveness in life.
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The Top 5 Effective Technical Indicators