The stock market always moves. The participants in this market try to make money from these apparent random moves.
The most common tool to rationalize the movements are technical indicators. Many indicators rationalize the market movement by way of finding patterns in movements. These patterns are commonly known as indicators.
Here we will discuss twelve such technical indicators which can be considered a must-know for all market participants.
Before moving further I would also like to add that no technical indicator alone can always be 100 percent true all the time. The market never fails to surprise us. Therefore a technical indicator will only help you to make an informed decision and help you make a correct decision most of the time. But there will be times when some unknown factors will influence the market trends and force the market to defy the trend. A trader must keep that always in mind.
The Use of Indicators in Technical Analysis
The indicators are the primary constituent of all kinds of technical analyses. These are considered technical tools or mere tools for technical analysis. In pattern analysis or technical analysis, there are many indicators. Stock market traders, who use technical indicators for trading or investing, use these historical patterns to project a probable future movement of the price of a stock.
There are two basic types of technical indicators: leading indicators and lagging indicators.
Leading indicators: A leading indicator is an indicator that tries to predict future price movement through chart patterns. The relative strength indicator is a leading indicator that measures price oscillations. The momentum indicator or momentum oscillator measures price changes over specific periods. It is also a leading indicator. The volume indicators or indicators that are primarily based on volume, can be either a leading or lagging indicator.
Lagging indicators: A lagging indicator usually follows the current trend. These indicators follow the historical background to measure the present trend by plotting the price action data. Examples of lagging indicators are Trend indicators, Mean reversion indicators, and other similar indicators.
Also read: Best Technical Analysis Softwares
List of 12 Must-know Indicators for Technical Analysis
1. Moving Average
The moving averages are of different types. Here we will talk about the most basic type of moving averages indicator known as Moving Average (MA) or Simple Moving Average (SMA).
The MA or SMA takes into account price movement over a specific period. The most common is 50 DMA ( daily moving averages of 50 days) or 200 DMA ( 200 days daily moving averages).
In a particular period, the price has four specific important calculation points – Open, High, Low, and Close. Commonly the closing price of a specific time period is considered for charting. But that can be customized as per choice.
We can derive the following trading information from the moving averages chart.
The moving average consists of two moving averages, the 50 MA and 200 MA. Now let’s see how we can practically use this information.
Trend
This is a current Nifty 50 chart. Here the closing price has been plotted in a 30 minutes time frame. The red color line shows the 50 periods 30 minutes closing price moving average chart. And the green line shows the 200 periods moving average price movement chart.
Here we can find three price trends:
When the price is above both the red and green lines, the index is in a sure uptrend. We can see the index is steadily moving upwards for a continuous long period. That shows a sure bull run.
In range-bound periods there is no trend strength. The price is moving between the two lines. The index came down below the 50-period simple moving average and moved in a zone above the 200-period simple moving average. Here you can see the price is moving in a zone that lies between 50 MA and 200 MA. After the index came below 50 MA, the index tried to make small upmoves that could not be sustained. Here price moves gave false signals or whipsaws. In a range-bound period, such false signals will arise. It is best not to make decisive trades in these periods
A downtrend occurred when prices came below both the red and green lines. When the price comes below both the short term and long term period moving averages, we can say it is trending down.
A crossover, as shown in the above chart, confirms the downtrend when the shorter period of MA ( 50 MA) goes below the longer period (200 MA). This confirmation helps traders to make assured trades.
This is how the MA or the SMA technical indicator helps the trader to take trades.
Read here: Complete guide to moving averages
2. Moving Average Convergence Divergence (MACD)
The moving average convergence divergence is more commonly known as MACD. The technical indicator takes into account the price momentum over some time by comparing two moving average indicators.
When two MA data come close two one another, convergence occurs. On the contrary, when the two moving average indicators move away from each other, the divergence occurs.
The MACD has three components. The first is the MACD line. This measures the difference between the two moving averages.
The next is the signal line. The signal line gives us the buy and sell signal by measuring the price momentum.
The last comes the histogram. The histogram shows the difference between the MACD line and the signal line.
Trade with MACD
The MACD chart consists of three time periods. The MACD line is created by subtracting data of 26 days MA from the 12-day MA. The signal line is the 9-period moving average line. The trading signal comes when at crossover data points of the two lines. The chart above shows the MACD line in black and the signal line in red.
Bullish signal: The chart above is a current daily chart of SBIN (State Bank of India). When the black line makes a crossover above the red line from below, a bullish signal occurs. We can see, that we got three bullish signals on the SBI chart. The first was during September, ’21 and then twice during the start of January, ’22 and then during mid of March, ’22. These bullish signals are buy signals when an investor or a trader can take a position in the stock.
Bearish signal: Similar to the bullish signals, we also got bearish signals during November ’21 and February ’22. The bearish signals actually sell signals. At these points, a trader should lighten the position already taken earlier. An informed trader sells SBI stocks already bought earlier at such points and waits for buying opportunities to make entry into the stock.
3. Relative Strength Index (RSI)
The relative strength index is commonly pronounced as RSI. It is a momentum indicator or momentum oscillator. We can easily identify when the stock is in an overbought or oversold position. There is a scale of 0 to 100 in the relative strength index RSI. When the average price of the stock reaches 30 or below, the chart indicates an oversold position. Likewise, if the relative strength index RSI shows a reading of 70 or above, the stock is expected to be in an overbought state.
The chart above shows an hourly chart of Reliance Industries. The oversold zones are in green and the overbought zones are marked red.
Trading signals
The overbought signal comes when the RSI reading goes above 70 and stays there. When the price goes to that level, the stock is considered overheated and the price may come down in the future. Traders are alerted. But it is seen that the stock may remain at that range at the trade for some time. So trader gets an alert that the stock has already entered an overheated zone.
Similarly, when RSI moves below 30, it is time for the trader to make a new entry into the stock. The trader buys the stock when other conditions favor the trade.
RSI gives only an alert signal. But this indicator alone is not powerful enough to generate exact entry or exit signals. A trader should consider other signals as well.
4. Bollinger Bands
Bollinger bands are price bands. This indicator is used as a volatility indicator. This indicator also helps us to understand the short-term and long-term market trends.
It consists of a two-line channel and a middle line. The middle line or the central line is the MA line and the channels are +2 and -2 standard deviations data points joined together.
The channels or the bands expand or contract continuously as the volatility of the stock increases or decreases. Extreme contraction indicates an imminent increase in volatility and alerts the trader of a future overheated price condition.
Also, when the price touches the upper band repeatedly, an overbought condition is attained. Similarly, when the price repeatedly hits the lower band, it indicates an oversold condition.
This is the current daily chart of Maruti. The middle line indicates a 20-period MA and the black lines are 2 standard deviations. Whenever the price touched the upper band or lower band repeatedly, price reversal occurred due to oversold or overbought conditions. Also, the short-term and long-term trends can be seen in the chart.
5. Stochastic oscillator
The Stochastic oscillator is a momentum oscillator. It helps us to understand the strength of the current price trend and the momentum. It is similar to the relative strength index as far as the 0-100 scale is concerned.
This oscillator has two main lines. The %K is mainline. The second line is %D. %D is MA of %K. Generally, the %K is represented by a bold line and the %D is represented by a dotted line. The stochastic oscillator can be interpreted in several ways.
The most popular interpretations are:-
- When any of the lines, %K or %D falls below 20 and then comes above the 20 levels then it is time to buy the stock. Similarly, when any line or both goes above 80 and then comes down, it shows a downward trend. Then it is time to sell.
- Else, buy when the %K line crosses the %D line and sell when %K goes below the %D line.
- Expect a reversal of trend when there is a divergence. Divergence occurs, say when the price of a stock makes new higher highs but the stochastic oscillator fails to surpass earlier highs
6. On Balance Volume (OBV) indicator
The on-balance volume indicator is a momentum indicator. It is one of the few indicators that take into account both the price and volume changes. OBV precedes price changes. It is a leading indicator. Volume is considered the prime factor that controls market trends.
Volume becomes positive volume when the price of the stock also goes up. Similarly, we have a negative volume. But at times, volume increases suddenly without price change. Then the price goes jumps suddenly. Smart money flows into stock with rising OBV. Then the public starts buying the stock resulting in a surge in both the on balance volume indicator and price of the stock.
7. Exponential Moving Average (EMA)
Exponential moving average or EMA is a lagging indicator. Similar to the MA, EMA shows the average price of the stock. But unlike MA where all price data are given equal weightage, in EMA the most recent price data is given more weight than previous ones through EMA charts. On account of this modification of EMA over MA or SMA, the current price trend becomes more visible. Also, the trader gets a more holistic idea of the price movement.
The chart above shows the current daily chart of SBIN using 13 periods EMA (red line) and 50 periods EMA (green line). The recent trend is more visible in this chart. The change of trend at every crossover is more prominent here.
8. Average Directional Index (ADX)
The average directional index or ADX is another of those few technical indicators that indicate the trend direction and strength of a stock. The indicator only signals the strength of the current trend. the ADX indicator has three main components. +DI, -DI and the signal line. +DI shows the positive directional index, -DI shows the negative directional index and the ADX line which shows the trend strength.
This is a chart of Maruti. It is a daily period chart showing ADX at the bottom. ADX chart has used 14 period SMA. The green line is +DI, the red line shows -DI and the black line is the ADX line. When the ADX line comes up from below and crosses the 25 mark, it shows a strong price trend. If ADX stays below 20, the market has no specific trend.
9. Commodity Channel Index (CCI)
The Commodity Channel Index (CCI) is an indicator that shows the variation of share prices from their statistical mean. This indicator can be applied to all stocks, not only to commodity charts though the name includes commodity.
As we now know that this indicator shows the variation of the prices of stocks from their mean price, a high value will show that the stock is currently trading at a price, that is long away from its mean or average price. Also, a low CCI value means the price is trading below its average price.
The CCI chart varies in a big range. A reading above +100 shows the stock is in the overbought zone. Alternately if the commodity channel index goes below -100, we need to understand the stock has entered an overbought zone. When CCI goes much above +100, it can be assumed that a correction is pending. Likewise, when CCI goes far below -100, a stock trader may assume that a rally is pending.
This is a daily chart of CIPLA. The lower portion of the chart shows a 20-period commodity channel index (CCI). When the stock prices moved too high, the CCI reading went above +100. The red zone in the chart indicates the stock is in the overbought zone. After a few days, the stock showed a correction. When the price was low, CCI entered into an oversold zone (green zone). A rally starts after that. But a stock trader must understand, that the rally or price correction is not always the same, as different market driving factor controls the trend and trend momentum.
10. Average True Range (ATR)
We all know that in the share market, volatility is an important factor. Volatility controls the price movement of the stock. Unless a trader gets the measure of volatility, a trader can not take advantage of big stock movements. The average true range or ATR gives you a measure of the volatility of the stock.
Analysts or seasoned traders of the market feel that higher volatility occurs at the top of the market or when prices of stocks reach the bottom. At the top of the price, curve bears enter the stock. But existing traders feel that the stock has more upside. This situation attracts more participants to join the trades. We see many trading activities and big bounces in prices within very short periods. Ultimately the bears win and pull the stock down.
At the bottom of the market, the market participants keep away from the market seeing there’s not much hope of return from the stock. At those times, if other conditions are favourable, the big players enter the stock. After a panic sell-off, a consolidation phase starts. At the end of this consolidation period, the bulls start entering. This causes the price to move upwards. After a small upmove, people start selling again in the hope of apprehension of another fall. After such a small sell-off again bulls enter at a lower price. After such moves repeat a few times, the price moves upward without much downward movement. Thus, at the bottom of the price curve, we can see high volatilities after which the bull run starts.
So, we can see, that at the top, we have high volatility periods. During high volatility periods, the ATR indicator moves up, giving us a sign that a trend reversal may take place. In the following chart of Maruti, we will see these clear signals.
Here ATR has considered the 14-period average SMA of price movement. It can be seen that when the price of Maruti stock reached the recent bottom, how the reading matched the top of the ATR. The ATR peaked at that point. We can also see that after that period, the ATR slowly subsides and the price of Maruti stock started going up. As already discussed earlier, the volatility reaches a maximum at the bottom. After this period, the price started going upwards.
This example above shows the utility of ATR in the most practical way. But ATR has multiple uses also. There are other indicators that are primarily based on ATR or Average True Range, like the Supertrend.
11. Open Interest (OI)
Open Interest or OI is a very strong technical analysis tool. Open interest or OI is the total number of contracts that are open at a particular point in time. It is an important part of the future and options market.
Why the future and options market? Such a question will automatically arise as till now we have taken into consideration only the equity segment of the stock market. Today, most of the leading stocks are enlisted in the future and options segment. Lion’s share of investment in the equity market flows into the future and options market. Hence, the market driving force comes from the future and options segment. The price movement also starts from the future and options market.
We can derive some very important information from the analysis of future and options data. Market trend, immediate support and resistance levels, future projections – all this information can be had from the future and options data analysis. Options data analysis gives us some of this important information. Other technical indicators, as discussed earlier, can not give us such important information. Take, for example, the support and resistance levels. Option data analysis gives us a clear view of it.
Important links: Check open interest data
12. Williams’ %R
It is a momentum indicator. Williams’ %R measures the oversold, overbought condition. This indicator is very similar to the stochastic indicator, but the scale is plotted upside-down. It is plotted in negative values. Though to read the chart we can ignore the negative symbol attached to numbers.
When the Williams’ %R gives a reading of -20 or more, the stock is in the overbought zone and likely to fall. Similarly, when the indicator comes down to -80 or less, the stock enters an oversold zone.
This is the current daily chart of Infosys. The red zone above -20, indicates the overbought zone. The green zone below -80 indicates oversold zones.
It is to be noted that even if the indicator shows the oversold or overbought zones, the price of the stock doesn’t start a reversal. Rather it continues to trade there for some time before taking a turn. Therefore, it is advisable not to take contrarian trades, unless the price takes a turn. The advantage of this indicator is that the indicator hits the top or bottom much before the price reversal. A trader can easily make an informed decision if he/ she judiciously follows the Williams’ %R indicator. Market turnaround can be seen easily much before the actual reversals.
Points to remember
There is no chart which is the best and can be treated that way. In different market conditions, different charts perform well. But a trader should remember that trader’s emotion or instinct should not override chart signals. Technical analysis charts are logical tools that help the trader to make money in the long run if the trader can use these tools judiciously.
Hence, a rational approach on the trader’s part is most important while using these tools. A calculative approach is essential.
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