There are multiple technical indicators available in the stock market. Some are based on extensive research, while others are just simple averages of prices. Many traders and investors use the technical indicators to time their entry and exit in the stock market. It helps them as a tool in their trading regime.
Before we know which are the most suitable indicators for intraday trading, let us know the types of indicators in the stock market and why they are used in the first place.
Based on the timing of information, technical indicators can be divided into two types, viz. (i) Leading indicators, and (ii) Lagging indicators. Let us briefly know about the two below.
A leading indicator is a type of indicator that aims to provide information before a price move is made. It is a gauge that shows when a price is about to go up or down. These indicators can only be used for guidance and not rely on them blindly.
The majority of the indicators give lagging information. It tells you about the reversal after the price has reversed. They can be triggered by historical data or price divergence. Divergence occurs when the price moves above a previous high but the indicator does not.
Indicators are the overlays that provide vital information about the chart and price movements. The indicators indicate how the price could behave shortly. This is difficult to predict unless various data points are merged to form valuable information. Indicators merge important data points to deliver reliable information which is easy to understand. Following are some factors included in technical indicators.
Momentum indicators are used for determining the strength of a trend and whether there is a possibility of reversal.
On-Balance Volume is a measure of how many stocks are being sold and bought over time. It shows how strong the move is when the price changes.
The trend indicators are often used to evaluate the direction of the market. They can also be used to identify potential trends.
A high volatility index shows how much the price is moving in the given period. A low volatility index shows how much the price is moving.
When it comes to digging into the technical analysis of charts, you will discover hundreds of indicators that you can apply to the charts to gauge future price movements. Some are leading indicators while
The moving average is a commonly used indicator for determining the direction of the market. It provides traders with important information about the current trends and the stop-loss levels. There are two types of moving averages – simple moving average (SMA) and exponential moving average (EMA).
A simple moving average is used to determine the average price of a selected range of prices. It simply adds the price of the share for a given number of periods and then divides the total with the number of periods to get a simple average price. SMA is little less sensitive to the share price movement.
The EMA does the same job as SMA, however, the simple moving average simply calculates average data whereas, the exponential moving average gives more weightage to the recent price movement. Due to this unique way of computation, the EMA is more sensitive to the price movements compared to the SMA.
The image provided below demonstrates both SMA and EMA. The red line represents SMA whereas the blue line represents EMA. You can understand how the EMA responds quickly to the price movements and reacts more sensitively compared to the SMA.
(Source: Fidelity.com)
The moving averages can be of different periods such as 5, 10, 20, 50, 100 period MAs. These periods represent the number of candles. For example, a 10 SMA on a 5 minutes chart indicates a simple moving average of closing values of ten candlesticks of 5 minutes.
That way, with each candle, one point is plotted on the chart. This moves forward with the formation of each new candle. Hence the name – ‘moving average’. In totality, these points form a line on a chart that acts as support or resistance for the stock price.
The relative strength index is a momentum indicator used to evaluate the market’s overbought and oversold status. It can be used to determine if the market is currently trending or not.
RSI is a line indicated by values ranging between 0 and 100. When the RSI reaches between 70-100, the stock is said to be in an overbought condition. On the contrary, when it reaches between the range of 0 to 30, the stock is said to be oversold.
The image below demonstrates how the share price that was oversold witnessed buying activity which took the price higher and how, when it reached the overbought zone, the buyers booked their profits by selling the shares.
(Source: Fidelity.com)
Instead of 70-30, some traders use 80-20 or 60-40 based on their needs. To know if the stock is in an uptrend or downtrend, the value of 50 is used as a midpoint. When RSI is above 50, the stock is said to be in an uptrend and when it is below 50, the stock is said to be in a downtrend.
Bollinger bands are used to indicate the volatility of the market. There are three bands in this indicator. A stock’s volatility is measured in these three different bands: a middle band, an upper band, and a lower band.
(Source: DailyFX.com)
The mid-band is a simple 20-period moving average. If the stock price is below the Bollinger Band lower line then it has the potential to increase in the future. Conversely, if the price is over the band upper line then it can be sold. You can understand this better by referring to the illustrative image given above.
MACD stands for Moving Average Convergence and Divergence. Convergence is a case where two moving averages move towards each other. And divergence is when the moving averages are moving apart. These two points indicate different scenarios in the stock price. MACD is based on exponential moving averages (EMAs).
(Source: DailyFX.com)
There are two lines in this indicator – one is the MACD line and the other is the signal line. MACD line is the difference between 26 and 12 periods EMAs. The signal line is a 9 period EMA. You can refer to the image provided above to understand better.
When the signal line goes above the MACD line, it is a buy signal and when it goes below the MACD line, a sell signal is generated. It is a very easy-to-use indicator. The buy and sell signals generated by the crossovers are marked in the illustration above.
The Bottom Line
While we are all in search of a holy grail to make profitable trades, it is far more rational to be realistic and accept the fact that such trading setups do not exist. Trading is, and will always be, a game of probability, and therefore, even if these technical indicators are used, one must plan and define the risks from trades and maintain a favourable risk-reward ratio at all times.
Yes, multiple indicators can be overlaid on one chart. However, the indications given by these indicators may clash and cause confusion.
Each indicator has its pros and cons and none of the indicators give results with 100% accuracy. Having said that, the most widely used intraday indicators are Moving Averages and RSI.
You can plot the moving averages on the chart provided on your trading terminal. In the settings, you can select the desired time frame and then plot the indicator. The MA lines will appear on your chart.
Every indicator has a different accuracy rate. It depends on the trader how the indicator is being used. With practice, the accuracy rate in using technical indicators can be increased.
While many individuals use technical analysis, even the investment banks and hedge funds are very active in extensively using the indicators.
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