In this article we are going to cover some basic technical indicators as well as when its appropriate to use them. With so many technical indicators out there it is difficult to not get caught up in all of them hoping that they will all give you a simultaneous buy signal. Given the nature of some technical indicators it is very unlikely that all indicators will tell you the same thing at any given time so its best to just stick to a couple when making trading decisions.
Trending indicators are best when used in trending markets. How do you identify a trending market you ask ? Simple. If a security is making higher highs and higher lows that security is trending up. Likewise if a security is making lower highs and lower lows then that security is trending down. If however a security doesn’t seem to fit any of those two definitions then you might be looking at the third case which is a security trading within a range. Using trending indicators with securities trading within a range isn’t appropriate and will likely give you many false signals. So what are the trending indicators ?
The MACD is one of the best known trending indicators. The MACD is composed of the moving average of two price averages as well as another shorter term moving average called the signal line. A MACD histogram shows you how much bullish momentum or bearish momentum a stock has. The MACD gives buy or sell signals in 3 ways.
- MACD line crossover
When the MACD line crosses above the signal line this is typically a buy signal. Likewise if it crosses below it this is typically a sell signal.
If you see the price of a security make a higher high but the MACD histogram make a lower high then be cautious as this typically signals the exhaustion of a trend.
- MACD cross above 0 line
This signal is not typically used however a cross above the 0 line can add some short term momentum to a stock.
Oscillating indicators are typically used with stocks trading within a range. In this section we will cover a couple of the most commonly used ones as well as what to look for when using them.
The RSI indicator is an oscillating indicator that gives readings between 0-100 with the levels 20 and 70 typically labelled as oversold or overbought. To use this indicator you would basically buy when the RSI crosses below the 20 line once it comes back above it and sell when the RSI crosses above the 70 line and comes back below it. Buying or selling just on a downward or upward cross of these two levels is dangerous given that a new trend may be forming.
Much like the RSI indicator the slow stochastic indicator gives an overbought or oversold reading with the same levels (20 and 70). This indicator however takes it an extra mile by having 2 lines (typically labelled as %D and %K). Typically when the %K and the %D are below 20 and move up from it if the %K is above the %D then this is a buy signal. Likewise when the %K and %D are above the 70 lines a cross below the %D is a sell signal.