Technical analysis is one of the most important components of any successful trading strategies. Technical analysis, which is notably different from fundamental analysis, uses a wide array of indicators to determine where a price is likely to move.
By paying attention to technical indicators, traders can determine near-term trends before they begin to unfold. This helps them identify unique opportunities to earn a profit while trading and, consequently, improve their ROI.
Before you begin any trading strategy—particularly a day trading strategy—it is a good idea to familiarize yourself with the best technical indicators for trading. This is especially true in highly liquid markets that operate 24 hours per day, such as the forex market and the cryptocurrency market.
Advanced trading theory is something that is constantly evolving. As you might expect, there are literally thousands of technical indicators available to choose from. The indicators that are most useful for you will depend on your risk tolerance, how long you plan to hold your positions, the markets you are trading in, and numerous other factors. In many cases, using multiple technical indicators together can help improve your technical analysis.
Below, we will discuss nine of the most effective technical indicators and how each can improve your outcomes as a trader.
1. Relative Strength Index (RSI)
The relative strength index is a popular momentum indicator, meaning it can be used to determine the strength and the direction of an underlying price trend. The index illustrates just how strong recent price movements can be, which can help you evaluate whether the underlying asset is overbought or oversold. The RSI gives a reading between 0 and 100, with values on the higher end (over 70) suggesting the asset is overbought and values on the lower end (under 30) suggesting the asset is oversold.
2. Simple Moving Average
The best thing about the simple moving average (SMA) is that, well, it is very simple. A 6-day SMA, for example, indicates the average closing price of an asset over the course of the past 6-days. In many situations, traders will look at multiple simple moving averages in order to detect ongoing price changes a bit more easily. For example, traders might overlay a 9-day SMA with a 22-day SMA and wait to see when one line crosses over the other. This might cause an experienced trader to open a position.
3. Exponential (Weighted) Moving Average
The Exponential Moving Average (also known as the weighted moving average) is similar to the Simple Moving Average but is designed to place extra emphasis on price movements that have occurred more recently. If a trader is planning on executing a short-term trading strategy, such as a swing trading strategy, they will naturally care much more about this week’s price movements than price movements that occurred three weeks ago. The exponential moving average helps provide the sort of balance between range and time professional traders are looking for.
4. Moving Average Convergence Divergence (MACD)
The Moving Average Convergence Divergence (MACD) is sometimes referred to as the “mother of all moving average indicators.” It combines two distinct exponential moving averages, the 26-period moving average, and the 12-period moving average, to detect statistically probably price movements and offer a clear signal line. Once the MACD crosses the signal line, traders will execute their positions. Usually, the “periods” being used refer to days, but intraday traders might apply the same logic of the MACD to an hourly price chart.
5. Andrews’ Pitchfork
The Andrew’s Pitchfork is one of several popular pitchfork trading indicators that can be used to identify levels of resistance and support, along with opportunities for a potential trend breakout or breakdown. Essentially, the “pitchfork” is constructed using three “confirmed” trend points, creating a trend band that’s projected forward. The key to successfully creating an Andrew’s Pitchfork is to determine where the trends actually begin. This can often be rather subjective, so it is a good idea to practice on paper before putting this into practice.
6. Bollinger Bands
Bollinger Bands are bands that make it easy to recognize the underlying asset’s typical price range. The bands are designed to contain 95 percent of all price movements, or two standard deviations worth of movements. Furthermore, the bands also help illustrate when there has been a change in volatility (relevant for many trading strategies). When Bollinger Bands are wider, that means markets have become more volatile. When they are narrow, that means markets are stabilizing.
7. Elliott Wave
Elliott Wave theory recognizes that, due to trading psychology and other forces, price movements often occur in “waves.” Two of the most notable waves Elliott Wave traders will look for include an impulse wave along with the corrective waves. Ralph Elliott, the influential theorist the theory is named after, believes these waves tend to occur in all markets and all asset classes if given enough time.
8. Fibonacci Ratios
Fibonacci ratios are found throughout our natural world. The stock market and other tradeable markets are no exception. Using fib ratio theory, traders will look at previous pivot points and attempt to guess what the next price movement is most likely to be. Fib ratios are especially useful in large-scale, relatively stable markets such as the forex market (USD: GBP). While using Fibonacci ratios cannot guarantee any position will be a winner, the historical data does support their usefulness.
9. Trading Volume
Lastly, trading volume will be one of the most useful technical indicators for traders to consider. Higher trading volume is strongly correlated with higher levels of volatility, along with a general increase in prices. Trading volume is most useful for traders that want to act quickly and also have a relatively high-risk tolerance. Looking at trading volume on a regular basis can help you determine where the market’s activity is concentrated.
Technical indicators can help provide the trading edge you’ve been looking for. By experimenting with multiple technical indicators and practicing on paper, you can hone your skills as a trader, improve the efficacy of your trading strategy, and, ultimately, improve your trading outcomes.