Best Indicators for Trading
Using trading indicators is part of any technical trader’s strategy. Paired with the It can be helpful to use technical analysis as part of your strategy – and this includes studying various trading indicators. Trading indicators are mathematical calculations, which are plotted as lines on a price chart and can help traders identify certain signals and trends within the market.
There are different types of trading indicator, including leading indicators and lagging indicators. A leading indicator is a forecast signal that predicts future price movements, while a lagging indicator looks at past trends and indicates momentum.
Best Trading Indicators
• Moving average (MA)
• Exponential moving average (EMA)
• Stochastic oscillator
• Moving average convergence divergence (MACD)
• Bollinger bands
• Relative strength index (RSI)
• Fibonacci retracement
• Ichimoku cloud
• Standard deviation
• Average directional index
A moving average (MA) is a widely used technical indicator that smooths out price trends by filtering out the noise from random short-term price fluctuations.
The most common applications of moving averages are to identify trend direction and to determine support and resistance levels.
Exponential Moving Average (EMA)
The EMA is a moving average that places a greater weight and significance on the most recent data points.
An EMA does serve to alleviate the negative impact of lags to some extent. Because the EMA calculation places more weight on the latest data, it “hugs” the price action a bit more tightly and reacts more quickly. This is desirable when an EMA is used to derive a trading entry signal.
A stochastic oscillator is a popular technical indicator for generating overbought and oversold signals.
The stochastic oscillator is range-bound, meaning it is always between 0 and 100. This makes it a useful indicator of overbought and oversold conditions. Traditionally, readings over 80 are considered in the overbought range, and readings under 20 are considered oversold.
Moving Average Convergence Divergence (MACD)
Moving average convergence divergence (MACD) is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA.
MACD triggers technical signals when it crosses above (to buy) or below (to sell) its signal line.
MACD helps investors understand whether the bullish or bearish movement in the price is strengthening or weakening.
Bollinger Bands are a technical analysis tool developed by John Bollinger for generating oversold or overbought signals.
There are three lines that compose Bollinger Bands: A simple moving average (middle band) and an upper and lower band.
Prices have a tendency to bounce within the bands’ envelope, touching one band then moving to the other band. You can use these swings to help identify potential profit targets.
A strong trend continuation can be expected when the price moves out of the bands. However, if prices move immediately back inside the band, then the suggested strength is negated.
Relative Strength Index (RSI)
The RSI provides technical traders with signals about bullish and bearish price momentum, and it is often plotted beneath the graph of an asset’s price.
An asset is usually considered overbought when the RSI is above 70% and oversold when it is below 30%.
True reversal signals are rare and can be difficult to separate from false alarms. A false positive, for example, would be a bullish crossover followed by a sudden decline in a stock. A false negative would be a situation where there is a bearish crossover, yet the stock suddenly accelerated upward.
Fibonacci retracement levels connect any two points that the trader views as relevant, typically a high point and a low point.
The most commonly used ratios include 23.6%, 38.2%, 50%, 61.8%, and 78.6%.
These levels should not be relied on exclusively, so it is dangerous to assume the price will reverse after hitting a specific Fibonacci level.
While the retracement levels indicate where the price might find support or resistance, there are no assurances the price will actually stop there. This is why other confirmation signals are often used, such as the price starting to bounce off the level.
The Ichimoku Cloud is composed of five lines or calculations, two of which comprise a cloud where the difference between the two lines is shaded in.
The lines include a nine-period average, a 26-period average, an average of those two averages, a 52-period average, and a lagging closing price line.
The cloud is a key part of the indicator. When the price is below the cloud, the trend is down. When the price is above the cloud, the trend is up.
Standard deviation is an especially useful tool in investing and trading strategies as it helps measure market and security volatility—and predict performance trends.
Standard deviation rises as prices become more volatile. As price action calms, standard deviation heads lower.
Market tops that are accompanied by increased volatility over short periods of time indicate nervous and indecisive traders. Market tops with decreasing volatility over long time frames indicate maturing bull markets.
Market bottoms that are accompanied by decreased volatility over long periods of time indicate bored and disinterested traders. Market bottoms with increasing volatility over relatively short time periods indicate panic sell-offs.
Average Directional Index
The average directional index (ADX) is a technical analysis indicator used by traders to determine the strength of a trend.
The ADX makes use of a positive (+DI) and negative (-DI) directional indicator in addition to the trendline.
The trend has strength when ADX is above 25; the trend is weak or the price is trendless when ADX is below 20.
If the ADX is declining, it could be an indication that the market is becoming less directional, and the current trend is weakening. You may want to avoid trading trend systems as the trend changes.