Technical Analysis is used by traders and analysts to gain insights into a stock or other securities using price action and volume of that particular stock or security. In order to become a successful trader or investor, you need to know the basics of technical analysis and about the best technical indicators used for technical analysis.
There are various technical analysis tools out there and used according to their needs. For further analysis and to know the best technical indicators, first, we need to know what is a technical indicator?
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What Is A Technical Indicator?
Technical indicators are pattern-based signals that are quite practical and produced by using the open-high-low-close price, volume, open interest of stocks, or financial securities used by traders or analysts who follows technical analysis.
Using these technical indicators, while trading in a stock or other security, they predict the future price movement and take trades according to the indications.
To be clear technical indicators work quite well in short-term trading and quite less important for long-term traders.
How Technical Indicators Works?
Technical indicators completely depend upon the price action of the stock or security and using the historical movement it predicts the future movement. Unlike fundamental analysis that focused on profit and loss, eps, price-to-earning ratio, technical analysis focuses on the historical price, volume, and open interest.
Technical analysis is often used by short-term traders, where a company’s profitability or fundamental have very less importance and price action and volume gets the higher priority.
Types of Technical Indicators
Basically there are two types of technical indicators.
- Overlays: Overlay technical indicators basically displayed over a chart simultaneous with the price movement. Examples: Bolliger Bands, Fibonacci Retracement tool, etc.
- Oscillators: Oscillators have a separate section with a local maximum and minimum and that is mainly displayed below the candlestick chart or whatever chart you use. Examples: MACD, RSI, Stochastic Oscillator, etc.
There are various types of traders and analysts out there in the market with different trading strategies and styles. There also thousands of technical indicators to use according to style and strategy. So, in this article, I am going to mention 7 best technical indicators for Day Trading or shorter-term trading.
7 Best Technical Indicators For Day Trading/Short-term Trading
There are so many technical indicators to choose from, but here is the list of 7 best technical indicators for day trading.
The accumulation/distribution index is a technical indicator that is a line intended to relate price and volume in a stock and other securities traded in the stock market. The indicator acts as a leading indicator to predict the price action.
It is being used to find out the divergence between the stock price and the volume action. This helps traders to measure how strong the trend is and vice-versa.
The rising accumulation/distribution line helps traders to confirm an uptrend and also confirm a downtrend. If the stock price is rising but the accumulation/distribution index is falling, it an early signal of weakness and a potential drop in price and vice-versa.
Moving Average Convergence Divergence – MACD
The Moving Average Convergence Divergence is a technical indicator and a momentum oscillator that mainly follows a trend and, is primarily used to find a stock’s trend.
MACD is calculated by subtracting a stock’s 26 periods Exponential Moving Average from the 12 periods EMA to form the MACD line. Then a 9-period exponential Moving Average known as “signal line” is plotted against the MACD line, which functions as a signal to buy or sell a security.
Traders and analysts generally go long on a stock when the MACD line crosses above the signal line and go short when the MACD line crosses below the signal line.
As the name suggests in MACD indicator convergence means ‘the state of converging’ and divergence means ‘the state of diverging’ of the two different EMAs (Exponential Moving Average).
Convergence happens in MACD while the moving averages are moving towards each other. Divergence happens when the moving averages are drifting apart from each other.
Relative Strenght Index – RSI
The relative strength index (RSI) is a technical analysis indicator that is developed by J. Welles Wilder. RSI is a momentum oscillator, that gauge the rate of rising and falling in the stock’s price.
RSI swings between 0 to 100 and when it reaches above 70% it is considered as overbought and if it drops below 30% it is considered as oversold.
In his book, “New Concepts in Technical Trading Systems”, J. Welles Wilder Jr. introduced RSI in the year 1978.
The formula to calculate RSI is:
RSI = 100 – (100/1+RS)
RS = Average Gain/Average Loss
The RSI provides analysts and traders, the signals about bullish and bearish price momentum of a stock or security, and the RSI chart is generally plotted beneath the chart of an asset’s price.
It is one of the few technical indicators that provide clear support and resistance figure and helps swing traders to get a complete benefit.
Bollinger Bands are a type of technical indicator used over a price chart characterizing the prices and volatility over a period of time of a stock or other securities, using a formulaic approach invented by John Bollinger in the 1980s.
Stock market traders employ these charts as a technical tool to make trading decisions as a component of technical analysis. Bollinger Bands display a graphical band that bag maximum and a minimum of moving averages in one two-dimensional price chart.
Bollinger Bands consist of an N-period simple moving average (SMA), an upper band at K times an N-period standard deviation above the simple moving average (SMA + Kσ), and a lower band at K times an N-period standard deviation below the simple moving average (SMA − Kσ).
The default values for N and K are 20 days and 2, sequentially. The default value can be changed as per the user’s choice and requirement. Exponential moving averages also can be used in Bollinger bands.
The upper line of Bollinger bands is considered as the resistance, the lower line is considered as the support and the middle line is considered as the trigger for buying and selling. Generally, swing traders make a profit with a lower period chart and Bollinger band.
Parabolic SAR (parabolic stop and reverse) is a technical indicator invented by J. Welles Wilder, Jr., to find potential traded in the stock market, commodity market and forex. Generally, it is considered as a trend-following indicator or lagging indicator.
The indicator mostly used to set a trailing stop loss or determine the potential entry or exit points based on the trading prices to stay within a parabolic curve during a strong uptrend or downtrend.
The parabolic SAR line is formed that is calculated independently for each trend in the price chart. Like when the price is in an uptrend, the SAR appears below the price and converges upwards near it. likewise, on a downtrend, the SAR appears above the price and converges towards downwards. Generally, the SAR is calculated one period in advance means tomorrow’s SAR value is calculated using today’s data.
The parabolic SAR technical indicator appears over a price chart as a series of dots, either above or below the price, depending on its direction.
The dots are placed below the price when it is in an uptrend, and above the price when it is a downtrend.
Double Top and Double Bottom
Double top and bottom patterns are quite a chart patterns rather than some statistical formula and it is considered a technical indicator. The pattern occurs when the stock or any underlying asset’s price chart looks like the English letter “M” and “W”.
The double top and double bottom are used in technical analysis to demonstrate movements in a stock or securities and are a part of the trading strategy to identify the recurring patterns.
The double top pattern forms when there are two consecutive rounding tops and looks like the letter “M”. When a double top pattern forms it is an indication to go short on the stock or other securities as a downtrend is expected after a double top pattern.
Likewise, a double bottom pattern forms when there is two consecutive rounding bottoms form (U shape) and looks like the letter “W”. The analysts and traders expect the following uptrend after a double bottom formation.
But, to be clear these chart patterns always depend upon the period of the chart the analysts using like 15 min or an hour or a day, which completely depends upon the trader.
Head and Shoulders Pattern
A head and shoulders pattern is a technical indicator and a chart formation that appears when a baseline forms with three peaks, the two of them are close in height and the middle is highest.
Using technical indicator, the head and shoulders pattern represents a specific chart formation that predicts a bullish-to-bearish trend and reveals. This pattern is considered as one of the most reliable and best technical indicators for Day trading.
The pattern is quite accurate and observed by most of the technical analysts. When this pattern forms it is very important to recognize it, to take suitable trade during the day.
Whatever technical indicators you use, make sure to analyze them correctly, and take notes on their effectiveness and your need over time. After several observations, you can also know the drawbacks of technical indicators and will know how to use them correctly.
There are literally, thousands of technical indicators out there, and choosing the best technical indicators is quite difficult. Many of them produce false signals, even the effective ones. So, using the period and type of chart is very important.
With good use and observations, you can get success when day-trading using technical indicators.