Introduction:
Indicators form a strategic part of any technical analysis strategy. However, they are numerous and each functions for different purposes. Some are used to gauge volume while others tell the general trend of the market. Here, we outline the top indicators that all traders across markets must know.
- Relative Strength Index
The Relative Strength Index (RSI) has a lot of uses but its most popular application is in measuring the strength of a trend. The RSI helps to determine if a market is overbought or oversold.
The indicator moves between 0 and 100. When RSI moves above 70, the market is considered overbought signaling a potential drop. When the RSI is below 30, the asset is oversold, showing a potential rally in the price.
Furthermore, traders use the RSI to determine support and resistance levels. During uptrends, price will often hold above the 30 level and occasionally touch 70 or above. When a stock is in a downtrend, the RSI will typically hold below 70 and frequently reach 30 or below; showing peak and bottom levels, hence making for an effective support and resistance.
- Moving Average (MA)
The Moving Average is, by far, one of the most popular indicators. Sometimes called the Simple Moving Average (SMA), the indicator is used to identify the direction of a current price trend over the long-term.
The data used by the MA depends on the period in the Moving Average. For instance, a 200-day MA represents 200 days of price points. By using the MA indicator, you can study levels of support and resistance and can also determine possible future patterns.
- The Average Directional Index (ADX)
The market moves in trends – either going up or going down; and this is what determines what type of trade you enter. However, either way, what is more important is whether the market can sustain that particular trend – up or down – for a longer time. In short, how strong is the momentum? The ADX can help determine that.
The ADX is a non-direction-specific indicator. It doesn’t clearly tell you whether the market will go up or down. What it is out to inform you is whether that up or down movement is strong enough, and whether it will last for long.
To use the ADX, follow the steps below:
Step 1 – The ADX is usually a single fluctuating line, plotted from 0-100. It is usually accompanied by two other lines, known as the Directional Movement Indicators (DMI). There is the +DMI which is for the uptrend, and the -DMI representing downtrend.
Step 2 – When the +DMI is above the -DMI, it indicates that the market is going up, while the ADX value tells us how strong the uptrend is.
When the -DMI goes above the +DMI, it forecasts that the market is going down, and the ADX measures the strength of the downtrend.
Step 3 – Whatever trend the market might be on, what you should pay attention to is the ADX figure. The current value of the ADX tells how strong the trend is.
0-25 – The trend is weak
25-50 – Trend is Strong
50-75 – Trend is very strong
75-100 – Trend is Extremely strong
- Volume Oscillator
The Volume Oscillator (VO) works on the principle that it is not the actual level of volume, but the change in volume relative to the very recent past that has more significance in determining the strength of a trend.
To keep things super simple, whenever there is a positive reading for the volume oscillator, it means that there is strength in the short-term in the direction of the primary trend. If the volume oscillator is in the negative territory, volume is lacking and a change in the current trend is likely to happen.
- Bollinger Bands
The Bollinger Bands tell you how “LOUD” or “QUIET” a market is. The Bollinger Bands are usually colored green, and have 3 bands, namely:
- Upper band
- Middle band
- Lower band
The Bollinger Bands mainly show how volatile a market is. That is, it tells how active the market is.
Step 1: When there is high volatility in the market, the bands expand – and stay far away from each other. So when you see the bands are considerably far from each other, you know the market is active and volatile.
Step 2: However, when there is low volatility, the bands contract and come close to each other.
It is not advisable for you to use indicators in isolation. When determining the trend or volume, you should aspire to check indicators across board.