Just about every trader, and especially everyone that engages in technical analysis, uses a variety of trading indicators to help instruct and determine what opening and closing positions to take on a trade.
If you’re an aspiring trader, it’s important to familiarise yourself with the best trading indicators every trader should know.
An indicator is the term for a statistic that is used to understand present or future financial trends in the market. Day trading indicators are used in all sorts of markets, including commodities, stocks and foreign exchange. Most indicators are based on mathematical formulas and expressed on charts that range over a specific period of time and are used to inform traders on how and when to execute their trading strategy.
Which are the top indicators you should be familiar with? We’ve outlined them below in no particular order and accompanied by a short explanation of what it is and what it’s used for.
The relative strength index or RSI indicator is a score based between 0 and 100. The relative strength of a particular financial instrument reflects various market conditions and tracks price momentum. Ideally it acts as a warning indicator for when overly drastic price fluctuations occur. The mid-range between 30 and 70 is considered relatively safe whereas either side of those parameters is thought to be oversold or overbought respectively. Anything that is overbought is thought to be due for a correction in pricing relatively soon, whereas oversold offers opportunity in the long-term increase in prices.
In the field of statistics, the term standard deviation refers to the amount of variation in a data or value set. When traders use a standard deviation indicator they are trying to identify the probability that future prices will be volatile and subject to change based on historical data. Of course, this indicator does not reflect which way the price movement is likely to move only that there is some fluctuation expected.
The moving average (MA) indicator seeks to determine which way a current price trend is leaning through the removal of abnormal, short term price changes. Like working out the average of any set of values, this indicator divides a combined number of price points by the number of points. This value is then expressed in a line to identify the trend. The more data incorporated in the indicator and the longer the period of time from which the data is pulled, the greater the ability to identify and extrapolate future trends.
Unlike the simple moving average indicator, the EMA indicator values data based on how recent it is. The more historical, the less emphasis placed on its importance. This particular indicator is more responsive to incorporating new data and news into the average, so it’s often used in conjunction with other indicators.
The moving average convergence divergence draws on the MA indicator but determines momentum changes in comparing two MAs. Often the MACD is used to identify support levels and resistance levels which can help influence a trader to either buy or sell. The term convergence refers to averages moving closer together, or in other words that the amount of change is getting smaller and smaller. The opposite, is referred to as diverging.
The Fibonacci indicator attempts to determine how much a price will fluctuate in opposition to the current trend. The term retracement means that the market is going through a temporary drop, confirmed through the use of the Fibonacci retracement to see where the support and resistance levels are. If traders are able to identify whether there is a downward or an upward trend they’ll be able to determine where they want to place their open positions and close positions.
This fancy sounding indicator is used by traders to compare a closing price of a financial instrument to its closing prices in the past. Through this comparison the stochastic oscillator indicates how strong a specific trend or momentum is. Like the RSI, it’s scored between 0 and 100, though in this instance the parameters for determining oversold or overbought are 80 and 20.
If you’re looking for the typical range of prices a specific financial asset normally closes within, the Bolinger band is the indicator for you. The greater the range the more the volatility, obviously. When closing prices fall outside of the band then it indicates that too many people are buying or trading that particular asset.
This is another indicator that is used for determining the level of support and resistance, though it also is used for determining momentum of prices as well. Some traders rely heavily on the Ichimoku cloud charts because of the high quantity (and hopefully high quality) of the information this indicator provides.
Often referred to as simply the ADX, the average directional index indicator is another one that falls on a 0-100 scale as part of its indication of the strength of a trend. This indicator doesn’t explain why a particular trend in pricing is forming but just points to the likelihood of that trend, be it upwards or downwards, continuing.
Indicators just indicate trends, volatility or momentum in the market. They aren’t fortune tellers or prophets of the future but rather signals that traders can use to help inform their strategy and decisions.
No matter how good an indicator is, it’s always a good idea to use multiple different indicators when conducting your research and executing your trading strategy. A great way to perfect your use of indicators is to practice using demo accounts and backtesting your indicator-informed strategy using historical data.
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