Fundamental analysis and technical analysis are the two skills that every investor should know for successful trading. Although they differ from each other yet they are equally important to learn as these indicators help stock market traders to get full insight into the stock.
Fundamental analysis is the study that directly affects a company’s potential value. This includes both macroeconomic and microeconomic factors as well as strategic planning, employee relations and supply chain.
What are Technical Indicators
Technical indicators also known as technical’s are used to see the past trends of stock and to anticipate the future price of a stock. Technical indicators have nothing to do with the basics of a company such as earnings, revenue, profit margin. The examples of technical indicators are relative strength index, moving averages and stochastic oscillators.
A technical indicator’s objective is to financial forecast direction. This can be achieved by calculating by historic price, volume and open interest information. Technical indicators are basically used to plot a chart pattern which in turn is used to predict the trend of the stock market. Technical indicators help analysts to predict the future price of the stock by looking at its past performance.
Here, we are outlining the top 5 technical indicators every stock market investor should know:
1. Relative Strength Indicator
The relative strength indicator helps analysts to identify momentum, market conditions and warning signals for risky price movements. RSI is classified as a momentum oscillator which tells a figure between 0 to 100. Here, momentum is the rate of the rise or fall of a stock price. An asset which is around 60-70 level is considered as overbought whereas an asset near 30 is considered as oversold.
Research analysts said that RSI is one of the most reliable indicators to ascertain accumulation and distribution phase. Also, it is helpful to measure the strength of the ongoing trend of stocks.
2. Moving Averages
Moving Averages or Simple Moving Average is one of the oldest and widely used technical indicators that is used to identify the direction of the current price trend without interrupting the short term price strike.
The formula of Moving Averages is the combined price points of a financial instrument over a specific period divided by the number of data points to present a single trend line. There are three types of Moving Averages: Simple moving average (SMA), exponential moving average (EMA) and weighted moving average (WMA).
Generally, common periods for moving averages are 10 days, 21 days, 50 days, 100 days and 200 days.
3. Bollinger Band
The indicator aims at providing a range within which the price of an asset generally trades. Also, Bollinger bands clearly reflect the volatility by increasing and decreasing the band.
Bollinger bands consist of a set of three band curves drawn that are expected to tell the security prices.
The primary function of the indicator is to provide a relative definition of high and low. As per the definition, the prices are high at the upper band and low at the lower band. The narrower the bands with each other, the lower the perceived volatility of the financial instrument. Conversely, the wider the bands, the higher the perceived volatility.
Bollinger Bands are useful for recognizing an asset, for instance, when an asset is trading outside the upper parameters of the band, it can be overbought or vice versa.
4. Moving Average Convergence Divergence
MACD is one of the widely used technical indicators to date. It detects the momentum of a stock by comparing two moving averages. It assists traders to identify buy and sell opportunities around resistance and support levels.
When two moving averages come together, it is known as Convergence, on the other hand, if they are moving away from each other, it is known as divergence.
The MACD line is used to compare the short term and long term momentum of stock so that analysts can identify its future direction. When the short term momentum line crosses the long term line, it clearly gives a sign of future stock activity. When the short term line crosses and surpasses the long term line, the stock will trade higher.
5. Average Directional Index (ADI)
ADX is used to measure the trend strength as it helps investors to quantify the strongest zone and increases the opportunity of building aggressive positions.
It works on a scale of 0 to 100, where a reading of increasing ADX value above 25 is considered as a strong trend while a value above 50 indicates exhaustion of a move where a number below 25 is considered a drift.
Analysts use this information in order to collect the data on whether the trend is going upward or downward.
Things to Ponder Before Using Technical Indicators
The foremost thing to remember to use trading indicators is that you should never use too many indicators at once nor in isolation. For better results, it is advisable to use a few indicators as they are best suited to what you are trying to achieve.
It is important to clearly monitor a signal for the best stock’s performance. For instance, if you are receiving a buy signal from an indicator and sell a signal from another indicator, then you have to use different indicators until your signals are confirmed.