Technical indicators are a click away on the chart, in the technical indicators menu, but there are so many options – do their signals provide the same value? No. Some of the indicators are more important than others, and we want to show you three of the most potent indicators that can help you predict the stock price with more accuracy. Here they are:
Moving averages (MAs) represent one of the most popular technical indicators and are used by all the traders, no matter their style, approach, psychology, and so on. An MA is a trend following indicator that helps you find the trend without being distracted by the price fluctuations and high volatility. It is worth mentioning that many other indicators are built based on moving averages. In fact, MAs are one of the oldest indicators for analyzing stock prices.
The main function of the MA is to average the stock price over a determined period. As the price fluctuates, its MA goes up or down as well. It is particularly important to watch the MA angle – if the indicator goes horizontally, then there is a sideways trend, and if there is a visible angle, then the price is trending. MAs with lower periods (fast MAs) are more volatile, while the ones with higher periods (slow MAs) tend to be smoother.
The best signal comes from at least two MAs – a fast MA and a slow MA. When the fast MA crosses the slow one from bottom to top, then it is time to buy, and vice versa.
In this example below you will see what the moving averages look like and what signals can generate a fast and a slow MA:
When we say moving averages, we refer to the simple ones, but there is also the exponential moving average (EMA), smoother moving average (SMMA), and the linear weighted moving average (LWMA). However, only the simple and the exponential MAs are used most of the time. The EMA pays more attention to the recent price movements against the older ones, which makes it more volatile. The SMA, on the contrary, is more balanced, giving equal consideration to both recent and older price changes.
The volume is particularly important in stock trading because it shows how active the traders were during a certain period. The trading volume is a great indicator because you can really understand how much traction a trend or a price rally has.
When the volume is higher, it suggests the market is stronger and you can have confidence in the current trend. A lower volume shows the weakness of a trend and traders prefer to stay away from entering the market because the trend is not so strong. Basically, volume is not just a profitable tool – it can also help you reduce risk.
Since volume is directly defined by the number of trades in the market, an increasing trend should be followed by a rising volume. The bulls want higher prices and increasing enthusiasm to continue their long positions. This is why when you see an uptrend but a decreasing volume, then there is a lack of interest and the trend may soon change its direction downwards. So, keep in mind that an apparently sharp trend with decreasing volume is not such a good signal. Volume is about market interest, and it has to support the trend.
When the stock goes up or down for quite a while, you can note exhaustion moves, which are sharp moves, which, along with higher volume, show a possible trend reversal.
Here is how the volume looks like on the chart. Note the exhaustion moves as well:
MACD is the abbreviation of moving average convergence/divergence. You will find this indicator in the form of bar graphs building a histogram. The MACD histogram will help you determine who is stronger – the bulls or the bears? Moreover, this indicator shows if the current market sentiment is getting better or worse.
The MACD is considered to be both a trend following indicator and an oscillator, because it shows momentum. This is why many stock traders call it one of the best technical indicators.
Remember when I explained the moving averages? I said there are many other indicators made of them. MACD is one of these. The MACD histogram shows the difference between two EMAs with different periods (which can be changed by the trader). On the histogram, you will see a signal line (a 9 period SMA set by default – which can be changed as well). This line can show more precisely when to go long or short.
Here is how you should read the MACD: when its histogram goes up, it indicates that bulls are more powerful than the bears, and it makes sense to go long. Conversely, when the histogram falls, it suggests that bears are stronger and you may want to short.
Also, take note of the MACD histogram basic rule – when the MACD goes below its signal line, this is a signal to sell, and when the histogram rises above its signal line, this is a buying signal. Also, you should watch how the MACD is crossing the zero line, because it suggests the market sentiment as well.
Here is how MACD looks on the chart:
In sum, this is a basic introduction to technical indicators and how to use them. We encourage you to refer to additional resources for a more in-depth understanding. Best of luck trading!