Trading Indicators Every Trader Should Know About
Trading indicators are a part of every trader’s tool kit. Some use it in simplistic forms to gauge the price behaviour while some take it to complex levels to hunt for profitable trading opportunities and manage risk.
Technical indicators are derivatives of past trading data that include price and volume. As the data is historical, trading indicators are generally considered lagging. However, that doesn’t, at all, make them less useful for traders. If used well, indicators can add huge value to any trader’s trading strategy.
Types of Indicators
Overlays: An overlay indicator is plotted alongside the price on the chart, using the same scale as the price. Indicators like moving averages and Bollinger bands fall under this category.
Oscillators: As the name goes, oscillating indicators move between the maximum and minimum values, showing overbought and oversold levels. Oscillators are plotted below or above the price chart.
The interpretation of both types of indicators is subjective and changes from trader to trader based on their trading strategy, style, and a host of other factors.
Here are the top indicators that every trader should know about.
A moving average is the average of price for a set time frame plotted alongside the price. The average keeps moving as the new price information is incorporated and the old price information is dropped.
For example, a 50-day moving average (50DMA) will be plotted by joining the moving averages of the last 50-days price. As new price data comes in each day, the 50th day is dropped and replaced by the latest day’s price.
Here is a chart of Apple Inc. with its 50DMA moving average line.
A rising moving average signifies an up trending price and a falling moving average signifies a down trending price. A flat moving average signifies a sideways price movement.
Traders use various timeframes on moving averages depending on their trading strategy. For example, a positional trader may use a 50DMA to enter and exit trades, while a short-term swing trader can use 21DMA.
Price crossing the moving average also signals a change in trend. A bullish crossover is when the price moves from below the moving average to above and vice versa for a bearish crossover.
You can also use a mix of moving averages to gauge how trends in different timeframes are shaping up. For example, a 21DMA moving from below to above 50DMA signifies that the short-term trend might have turned up. If both the moving average start trending up after the crossover, that would mean that both short and medium trend has turned up.
Moving averages further have two types - simple and exponential. Simple moving averages give equal weights to prices across the time frame, while exponential moving averages give higher weightage to the current price, therefore being more responsive to recent moves.