MACD to MA: 5 Proven Technical Indicators

5 Technical Indicators

Stock traders often use a variety of different technical indicators when trying to predict the future price movements of stocks. These include Moving Average Convergence/Division (MACD), Moving Average Crosses (MACs), as well as other similar tools such as RSI or Stochastic oscillators.

While there is no denying that these tools can be useful, it’s important to note that they’re not always accurate. They also have their limitations, which means using them alone will rarely result in profitable trades on a consistent basis.

That said, if you know how to combine multiple technical indicators together into one system, and you’ve got decent stock charting software, then this may help increase your chances of making money consistently.

Let’s take a look at some of the most widely-used technical indicators out there. We’ll discuss what each tool does, along with its strengths and weaknesses, so you understand why they work the way they do. By learning about these tools more thoroughly, you’ll become better equipped to craft an effective strategy based around them.

What are Technical Indicators in Trading?

In order to discuss technical indicators, we must first define exactly what they are. In general terms, they provide information regarding past performance, forecast future trends, and allow us to make educated predictions about the near-term movement of prices.

This makes them extremely useful for predicting market behavior over time. The following list includes several common technical indicators, including their function, purpose, and usage examples.

Now let’s get familiar with all the major technical indicators currently used by professional investors. While many of them perform similarly, some offer unique advantages depending on the type of trader. Here’s our list of six favorite technical indicators:

MACD

One of the earliest-developed technical indicators, MACD stands for “Moving Average convergence/division.” The two components of MACD are called MACD(l) and MACD(h). MACD(l) represents the lower line of the indicator while MACD(h) denotes the upper line.

Both lines track momentum changes within a specific range. When both lines point upwards, this indicates bullishness. On the contrary, points pointing downwards signal bearish conditions.

MACD is one of the top five trending financial indicators today. Some even argue that it’s the best trend detector available for day traders. When plotting the MACD indicator, it should ideally move between -80 and +100.

If it falls outside this range, it could indicate either strong buying or selling pressure. Typically, however, a healthy value of 0 would mean neutral sentiment. The MACD is calculated by subtracting the 26 period exponential moving average from the 12 period EMA.

Using MACD correctly requires experience. First off, you need to learn where the indicator begins crossing above or below zero. Next, pay attention to whether the upward slope or downward slope is steeper than the prior slope. Lastly, keep an eye on the crossover rate, which determines how quickly the values cross over.

Moving Averages (MAs)

Also known as Exponential Moving Averages (EMAs), MAs represent the average growth rate of a series. They typically consist of three numbers: the opening, closing, and length parameters.

The length parameter is simply the amount of periods included in the averaging process. For example, if a particular security has 30 days worth of history, then its daily EMA consists of 15 days’ worth of historical data.

You can think of EMAs as lagging indicators because their calculations only focus on recent activity. As such, EMAs tend to reflect short-term fluctuations rather than long-term tendencies. However, this isn’t always true. There are situations wherein EMAs are very good at forecasting future trends.

To illustrate, imagine you own shares of ABC Co. Shares rose sharply during 2020, but fell significantly during 2021. An investor might conclude that the company had been performing poorly throughout the entire year due to bad management. But if he looked deeper, he’d notice that the company actually experienced growth since 2019.

Hence, although the company did suffer setbacks last year, it still managed to grow overall. Therefore, looking at the company’s yearly EMA provides valuable insight. A stock’s EMA tells you something important about the underlying business fundamentals.

Because the EMA takes account of previous results, it tends to lag behind actual developments. Thus, if you spot sudden shifts in an EMA chart, it’s likely that something changed recently. For instance, perhaps a new executive took charge, causing the share price to drop dramatically.

Or maybe people lost confidence in the company’s ability to deliver on promises, leading to further losses. Either way, taking immediate action can turn things around.

Bollinger Bands

Another classic indicator that shows volatility levels is known as the Bollinger Band. It essentially displays bands surrounding the standard deviation of returns seen in a given asset class. Traditionally, stocks were thought to follow Gaussian distributions due mainly to their small size.

With larger companies becoming popular, though, deviations began appearing and growing increasingly wide. Investors started noticing these widening gaps and realized that large moves weren’t uncommon, so they sought ways to quantify risk and improve decision-making. Enter John W. Henry & Co.’s Andrew L. Bollinger Jr.

To create the Bollinger band, start by calculating the standard deviation of a collection of historic equity prices. Take the square root of this figure and add it to 200%. This yields the maximum possible fluctuation, whereas subtracting 100% produces the minimum.

Now plot a horizontal line parallel to the median price on every bar in the chart. Any bars whose lows fall below this line signify extreme volatility. Conversely, any highs that exceed this line suggest moderate stability.

This method proved reliable enough, but as markets became increasingly volatile, it wasn’t updated accordingly. Fortunately, after 2000, Bollinger came up with another version of the band that factors in wider fluctuations.

Instead of drawing a straight vertical line across the center of the bar, draw a curved line that starts 40 pips away from the midpoint and extends horizontally until the end of the bar. Anything inside this curve signifies greater stability. Likewise, anything beyond it suggests increased volatility.

Bollingers are among the simplest yet most influential technical indicators. And unlike most other tools, they consider volume alongside price. Thanks to this, Bollinger Bands can identify sudden drops or increases in volatility regardless of direction.

Relatve Strength Indicator (RSI)

Introduced in 1992 by mathematician Richard Donchian, RSI tracks positive versus negative momentum over time through a scale ranging from 0 to 100. If an index reaches 90, that signals a perfect buy signal. Similarly, reaching -30 indicates a sell alert.

Rising RSI values generally denote rising markets, while falling ones reflect declining sectors. At 60+, the indicator becomes less sensitive as market participants begin paying closer attention to shorter-term news flow.

Furthermore, whenever RSI crosses above 70, it’s considered quite bullish. Below 55, the opposite holds true. Unlike MACD, RSI considers both positive and negative momentum simultaneously.

Also, it uses a faster algorithm. Additionally, RSI offers additional insights, such as determining support and resistance levels, identifying bottoms and tops, and pinpointing exact entry and exit points. All of these features make RSI ideal for intraday strategies.

Don’t forget you can customize your RSIs with most popular charting software. You can almost always adjust the overbought and oversold values. By default, most software considers above 80 to be overbrought and 20 to be oversold.

Stochastic Oscillator

First introduced in 1966, the S&P 500 Stochastic Index measures the velocity of price change against time. Its output ranges from 0 to 100. Like RSI, S&P500 oscillates between two extremes–a buy zone and a sell.

It compares the most recent closing price of a stock (or any security) to the highest and lowest prices during a given time period. They are basically a way to quantify a security’s trading range during the set time period. The most commonly used period is 14 days, although most software allows you to adjust this parameter.

A value of 100 indicates the highest point during the specified period, while a value of 0 indicates the lowest point. The stochastic oscillator can be plotted by first calculating the K and D lines:

  • %K = 100 x (most recent closing price – lowest price of last 14 sessions) / (highest price during last 14 sessions – lowest price of last 14 session)
  • D = 100 (highest price of last 3 sessions / lowest price during same 3-day period)

Your trading software, even the free ones, will do all the calculations for you. Alternatively, you can calculate it yourself in Sheets, Open Office, or Excel by following the instructions here.

The D line moves slower than the K line and is generally the main thing you want to look at. A stock is usually considered overbought once it hits a value of 80, while it would be called oversold at a value of 20.

In Conclusion

The five most popular technical indicators for stock traders are the MACD, MAs, Bollinger Bands, RSI, and the stochastic oscillator. Many traders make the mistake of filling their charts up with indicators thinking that more is better, but what happens is they begin presenting information that may look contradictory.

This makes it impossible to decide on a definite buy or sell signal. Instead of attempting to use all of these at once, it is best to pick a solid couple of indicators, perhaps ones you understand the best, and stick to them. Remember: practice makes perfect when it comes to interpreting technical indicators!

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