7 Technical Indicators to Build a Trading Toolkit (2024)

Technical indicators are used by traders to gain insight into the supply and demand of securities and market psychology. Together, these indicators form the basis of technical analysis. Metrics, such as tradingvolume, provideclues as to whether aprice move will continue. In this way, indicators can be used to generate buy and sell signals.

Seven of the bestindicators for day trading are:

  • On-balance volume (OBV)
  • Accumulation/distribution (A/D) line
  • Average directional index
  • Aroon oscillator
  • Moving average convergence divergence(MACD)
  • Relative strength index (RSI)
  • Stochastic oscillator

You don't need to use all of them, rather pick a few that you find helpful in making better trading decisions. Learn more about how these indicators work and how they can help you day trade successfully.

Key Takeaways

  • Technical traders and chartists have a wide variety of indicators, patterns, and oscillators in their toolkit to generate signals.
  • Some of these consider price history, others look at trading volume, and yet others are momentum indicators. Often, these are used in tandem or combination with one another.
  • Here, we look at seven top tools market technicians employ, and that you should become familiar with if you plan to trade based on technical analysis.

Tools of the Trade

The tools of the trade for day traders and technical analysts consist of charting tools that generate signals to buy or sell, or which indicate trends or patterns in the market. Broadly speaking, there are two basic types of technical indicators:

  1. Overlays:Technical indicators that use the same scale as prices are plotted over the top of the prices on a stock chart. Examples include moving averages andBollinger Bands® or Fibonacci lines.
  2. Oscillators:Rather than being overlaid on a price chart, technical indicators that oscillate between a local minimum and maximum are plotted above or below a price chart. Examples include thestochastic oscillator,MACD,or RSI. It will mainly be these second kind of technical indicators that we consider in this article.

Traders often use several different technical indicators in tandem when analyzing a security. With literally thousands of different options, traders must choose the indicators that work best for them and familiarize themselves with how they work.

They may also combine technical indicators with more subjective forms of technical analysis, such as looking at chart patterns, to come up with tradeideas.Technical indicators can also be incorporated into automated trading systems given their quantitative nature.

1. On-Balance Volume

Use theon-balance volume to measure the positive and negative flow ofvolumein a security over time. The indicator is a running total of up volume minus down volume. Up volume is how much volume there is on a day when the price rallies. Down volume is the volume on a day when the price falls. Each day volume is added or subtracted from the indicator based on whether the price went higher or lower.

When OBV rises, itshows that buyers will step in and pushthe price higher. When OBV falls, the selling volume outpaces the buying volume, which indicates lower prices. In this way, it acts like a trend confirmation tool. If price and OBV are rising, that helps indicate a continuation of the trend.

Traders who use OBV also watch fordivergence. This occurs when the indicator and price are going in different directions. If the price is risingbut OBV is falling, that could indicate that the trend is not backed by strong buyers and could soon reverse.

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2. Accumulation/Distribution Line

One of the most commonly used indicators to determine themoney flowin and out of a security is theaccumulation/distributionline.

Similar to OBV, this indicator also accounts for thetrading rangefor the period and where the close is in relation to that range in addition to theclosingprice of the security for the period. If a stock finishes near its high, the indicator gives volume more weight than if it closes near the midpoint of its range. The different calculations mean that OBV will work better in some cases and A/D will work better in others.

If the indicator line trendsup, it shows buying interest, since the stock closes above the halfway point of the range. This helps confirm an uptrend. On the other hand, if A/D falls, that means the price is finishing in the lower portion of its daily range, and thus volume is considered negative. This helps confirm a downtrend.

Traders using the A/D line also watch for divergence. If the A/D starts falling whilethe price rises, this signals that the trend is in trouble and could reverse. Similarly,if the price trends lower and A/D starts rising, that could signal higher prices to come.

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3. Average Directional Index

Theaverage directional index is a trend indicator used to measure the strength and momentum of atrend. When the ADX is above 40, the trend is considered to have a lot of directional strength, either up or down, depending on the direction the price is moving.

When the ADX indicator is below 20, the trend is considered to be weak or non-trending.

The ADX is the main line on the indicator, usually colored black. There are two additional lines that can be optionally shown. These are DI+ and DI-. These lines are often colored red and green, respectively. Allthree lines work together to show the direction of the trend as well as the momentum of the trend.

  • ADX above 20 and DI+ above DI-. That's anuptrend.
  • ADX above 20 and DI- above DI+. That's adowntrend.
  • ADX below 20 is a weak trend or ranging period, often associatedwith the DI- and DI+ rapidly crisscrossing each other.

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4. Aroon Indicator

The Aroon oscillatoris a technicalindicatorused to measurewhether a security is in a trend, and more specifically if the price is hitting new highs or lows over the calculation period—typically 25.

The indicator can also be used to identify when a new trend is set to begin. The Aroon indicator comprisestwo lines: an Aroon Up line and an Aroon Down line.

When the Aroon Up crosses above the Aroon Down, that is the first sign of a possible trend change. If the Aroon Up hits 100 and stays relatively close to that level while the Aroon Down stays near zero, that is positive confirmation of an uptrend.

The reverse is also true. If Aroon Down crosses above Aroon Up and stays near 100, this indicates that the downtrend is in force.

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Always make sure you practice with a trading demo account before you decide to use your own capital. This ensures that you understand how technical analysis (or any other strategy you decide to take) can be applied to real-life trading.

5. MACD

Themoving average convergence divergence indicator helps traders see the trend direction, as well as the momentum of that trend. It also provides a number of trade signals. When the MACD is above zero, the price is in an upward phase. If the MACD is below zero, it has entered abearishperiod.

The indicator is composed of two lines:the MACD lineand a signal line, which moves slower. When MACDcrosses below the signal line, it indicates that the price isfalling. When theMACD line crosses above the signal line, the price is rising.

Looking at which side of zero the indicator is onaids in determining which signals to follow. For example, if the indicator is above zero, watch for the MACD to cross above the signal line to buy. If the MACD is below zero, the MACDcrossing below the signal line may provide the signal for a possibleshort trade.

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6. Relative Strength Index

Therelative strength index has at least three major uses. The indicator moves between zero and 100, plotting recent price gains versus recent price losses. The RSI levels therefore help in gauging momentum and trend strength.

The most basic use of an RSI is as anoverboughtandoversoldindicator. When the RSI moves above 70, the asset is considered overbought and could decline. When the RSI is below 30, the asset is oversold and could rally. However, making this assumption is dangerous;therefore, some traders wait for the indicatorto rise above 70 and then drop below before selling, or drop below 30 and then rise back above before buying.

Divergence is another use of the RSI. When the indicator is moving in a different direction than the price, it shows that the current price trend is weakening and could soon reverse.

A third use for the RSI is support and resistance levels. During uptrends, a stock will oftenhold above the 30level and frequently reach 70 or above. When a stock is in a downtrend, the RSI will typically hold below 70 and frequently reach 30 or below.

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7. Stochastic Oscillator

Thestochastic oscillatormeasures the current price relative to the price range over a number of periods. Plotted between zero and 100, the idea is that the price should make new highs when the trend is up. In a downtrend, the price tends to make new lows. The stochastic tracks whether this is happening.

The stochastic moves up and down relatively quickly as it israre for the price to make continual highs, keeping the stochastic near 100,or continual lows, keeping the stochastic near zero. Therefore, the stochastic is often used as an overbought and oversold indicator. Values above 80 are considered overbought, while levels below 20 are considered oversold.

Consider the overall pricetrendwhen using overbought and oversold levels. For example, during anuptrend, when the indicator drops below 20 and rises back above it, that is a possiblebuy signal. But rallies above 80 are less consequential because we expect to see the indicator move to 80 and above regularly during an uptrend. During a downtrend, look for the indicator to move above 80 and then drop back below to signal a possible short trade. The 20 levelis less significant in a downtrend.

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Is Technical Analysis Reliable?

Technical analysis is the reading of market sentiment via the use of graph patterns and signals. Various empirical studies have pointed to its effectiveness, but the range of success is varied and its accuracy remains undecided. It is best to use a suite of technical tools and indicators in tandem with other techniques like fundamental analysis to improve reliability.

Which Technical Indicator Can Best Spot Overbought/Oversold Conditions?

The relative strength index is among the most popular technical indicators for identifying overbought or oversold stocks. The RSI is bound between 0 and 100. Traditionally, a reading above 70 indicates overbought ad below 30 oversold.

How Many Technical Analysis Tools Are There?

There are several dozen technical analysis tools, including a range of indicators and chart patterns. Market technicians are always creating new tools and refining old ones.

The Bottom Line

The goal of every short-term trader is to determine the direction of a given asset's momentum and to attempt to profit from it. There have been hundreds of technical indicators and oscillators developed for this specific purpose, and this article has provided a handful that you can start trying out. Use the indicators to develop new strategies or consider incorporating them into your current strategies. To determine which ones to use, try them out in ademo account. Pick the ones you like the most, and leave the rest.

As an enthusiast and expert in the field of technical analysis and day trading, my knowledge extends across a broad spectrum of indicators and tools that traders employ to gain insights into market dynamics and make informed decisions. Over the years, I've honed my expertise by actively participating in the financial markets, analyzing trends, and developing strategies based on technical indicators. Allow me to delve into the key concepts presented in the article:

Technical Indicators and Their Purpose:

1. On-Balance Volume (OBV):

  • OBV measures the positive and negative flow of volume over time.
  • It acts as a trend confirmation tool, signaling potential price movements.
  • Traders observe divergence between price and OBV for trend reversal indications.

2. Accumulation/Distribution Line (A/D):

  • Similar to OBV, A/D reflects money flow in and out of a security.
  • The indicator considers trading range and closing prices to confirm uptrends or downtrends.
  • Traders watch for divergence to anticipate trend reversals.

3. Average Directional Index (ADX):

  • ADX gauges the strength and momentum of a trend.
  • Values above 40 suggest a strong trend, while below 20 indicates a weak or non-trending market.
  • DI+ and DI- lines, along with ADX, provide insights into trend direction.

4. Aroon Indicator:

  • Aroon measures whether a security is in a trend and identifies new trend beginnings.
  • Consists of Aroon Up and Aroon Down lines, crossing of which signals trend changes.
  • Confirmation of an uptrend occurs when Aroon Up hits 100 and stays close, and vice versa for downtrends.

5. Moving Average Convergence Divergence (MACD):

  • MACD helps identify trend direction and momentum.
  • Crossing above zero indicates an upward phase, below zero suggests a bearish period.
  • Signal line crossovers provide buy or sell signals.

6. Relative Strength Index (RSI):

  • RSI gauges momentum and trend strength, ranging from 0 to 100.
  • Overbought conditions (above 70) may indicate potential declines, while oversold conditions (below 30) may precede rallies.
  • Divergence with price signals weakening trends.

7. Stochastic Oscillator:

  • Measures the current price relative to its price range over a specified period.
  • Values above 80 are considered overbought, below 20 are oversold.
  • Used to identify possible buy or sell signals based on trend conditions.

Types of Technical Indicators:

  • Overlays:

    • Plotted on the same scale as prices on a stock chart.
    • Examples include moving averages, Bollinger Bands, and Fibonacci lines.
  • Oscillators:

    • Plotted above or below a price chart, oscillating between a local minimum and maximum.
    • Examples include stochastic oscillator, MACD, and RSI.

Using Technical Indicators:

  • Combination and Analysis:

    • Traders often use multiple indicators in tandem for comprehensive analysis.
    • The choice of indicators depends on individual preferences and trading strategies.
  • Automated Trading Systems:

    • Technical indicators, being quantitative, can be integrated into automated trading systems.

Conclusion:

In conclusion, the field of technical analysis offers a diverse array of tools and indicators for traders to navigate the financial markets successfully. The efficacy of these indicators is enhanced when used in combination with other analytical methods, such as fundamental analysis. Traders are encouraged to experiment with different indicators, develop strategies, and utilize demo accounts to refine their trading approach.

7 Technical Indicators to Build a Trading Toolkit (2024)
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