Indicators are a great way to read and evaluate a graph with technical aspect. It helps us to better understand stock price action. For example, if there is a sudden huge spike on the upside or downside, the volume indicators are most likely spiking as well. If that is the case, then you can verify online for any new announcements or news that may affect stock price positively or negatively. Every indicator has its own purposes and can or cannot be used depending on your style of trading. A combination of indicators level and support/resistance level can be great entry and exit points.
Some indicators can be applied directly on the chart around the candle sticks, such as the moving average indicators. The other indicators will be added at the bottom of the graph and displaying their own graphs following the same x-axis time units as your main graph.
In the following article, we will go through a few indicators that we consider essentials to be aware of. This does not mean that all theses indicators need to be used all at once but understanding them will give you an extra edge over your trades.
How to add an indicator?
Every brokerage may differ from one another, however they should all have an ‘add indicators’ or ‘indicators’ sections. The element to pay attention to is when an indicator is selected, there will be some additional settings that can be edited such as a value, color, and line settings. For example, the moving average indicators can have different length as in inputs which can be any values from 1 to 500. Hence, the use of the right settings is just as important as the use of different indicators to display the information you desire.
Essential Indicators to understand
1. Moving averages (MA, SMA, EMA)
There are two types of moving averages, simple moving average, and exponential moving average (EMA). In the case where its written moving average, it will most likely mean simple moving average. Both types have for goal to take of the previous candle values and make an average of them. This indicator can be used as a reference point for future price actions.
In the case for the simple moving average (SMA) you choose the length to be 2. This means that if you look at the daily time interval chart, it will take the previous 2 candle sticks, each representing a day, take their closing price, and calculate the average of it. For example, if the closing price on the first day is 20$ and the second day its 30$ then the SMA for the second day will have a value of $25. Now if you read the 1 minute time interval chart still having the SMA length to 2, it will take the average of the last 2 candles, each representing a minute.
The difference between the SMA and the EMA is that the EMA uses a smoothing factor in the formula that makes its line flatter then then SMA. Note that if you display both lines for the same length, you will notice that they are very similar. Since EMA has a smoothing factor, it will be more of a passive approach, and the SMA will be more of an aggressive approach.
The moving average indicators is a great indicator to see if the price action is above or below the average of a set length. Some traders like to set the SMA or EMA at a length of 9 and whenever there is a full green candle above the moving average, they will buy the stock and when price action retracts back to the moving average, they will sell it. This is also called buying at confirmation and selling at validation. This method will be explained in future article.
Moving average with a higher length like for example 50, 100, 180, 200 are used to see the overall trend of the stock. If it is trading above those levels, the stock is in a bullish trend. If the price action is lower, then those moving averages it is in a bearish trend.
Hence, moving averages are great indicators for short term or long term evaluations since it allows us to refer to the average price of a set length.
2. Relative Strength Index (RSI)
The relative strength index is a reference tool to evaluate if a stock is more on the overbought level or oversold level based on 14 candles depending on your chosen time intervals. The time periods adjust to the time interval. The RSI values range from 0 to 100. If the RSI value is lower than 30, the stock is considered oversold and if the RSI value is above 70, the stock is considered overbought.
The calculation behind this metric is based on the gain percentage, the loss percentage over the default period length of 14. The length period can be changed in the RSI settings.
This tool is a momentum indicator that adjusts to the time frame. It is very useful when it hits level around 20 or 80 because it indicates that its very overbought or very oversold. For the example where the RSI is at 80, we know that the price action is very overbought so that a great point to make an exit because we know that it will not stay overbought forever. As much as we would like it to keep going to the overbought area higher than 80, it will retrace to lower level. The same thought process can be done when the RSI is very oversold at levels around 20.
3. Moving Average Convergence Divergence (MACD)
The moving average convergence divergence (MACD) is a direction indicator. It is composed of two lines, one is the signal line and the other the MACD line. The MACD line and the signal line colors may differ from a brockage to another. An easy way to identify the lines is by understanding the purpose of the MACD indicator.
When the MACD line is above the signal line, we are in an upward trend.
When the MACD line is below the signal line, we are in a downward trend.
Now that we know that the position of the MACD line, in respect to the signal line, indicated the overall trend direction. The crossover of both lines is the turnover point from one direction to another. Also, the higher the gap between the two lines above the base value 0, the higher the uptrend momentum. Also, the higher the gap between both lines below the base value 0, the higher the downtrend momentum.
The volume indicated the number of shares that are traded. A stock with great volume is better for greater price fluctuation. In other terms, if there is not much volume, the price will barely move up and down making the stock not a good one to trade with. Day trading stock should have a volume of around 15 000 per minute. Lower than that will be hard to trade with, and the chart will be filled with choppy candlesticks.
The volume indicators are also a great way to analyze for sudden increases or decreases in demand over the past few days by looking at the variation in volume numbers. More specifically, you know there is something happening when a stock that usually trades at around 100 000 trades per minute has a sudden spike to 1 million trades per minute from one minute to another.
There are more indicators that can be used than the 4 discussed above. The key is to find the ones that you prefer using and understanding price action, support, and resistance levels.