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One way traders seek to profit from short-term movements in security prices is by using technical analysis.

While some stock analysis tools examine company fundamentals, technical stock indicators identify patterns in price and volume data to give investors and traders insights about how a stock might move in the future.

For that reason, although technical indicators can assist with trend identification, it’s best to combine different indicators when conducting stock analysis.

How Do Stock Technical Indicators Work?

Technical analysis uses various sets of data and indicators, such as price and volume, to identify patterns and trends. This type of stock market analysis is different from fundamental analysis, which looks at company financials, industry trends, and macroeconomics.

Rather, technical analysis solely analyzes a stock’s performance. Stock technical indicators are often rendered as a pattern that can overlay a stock’s price chart to predict the market trend, and whether the stock would be considered “overbought” or “oversold.”

Two Main Types of Technical Indicators

Stock technical indicators generally come in two flavors: overlay indicators and oscillators.

Overlay Indicators

An overlay indicator typically overlays one trend onto another on a stock chart, often using different colors to distinguish between the lines.

Oscillator Indicators

An oscillator typically uses metrics such as a stock’s price or trading volume to determine momentum, or rate of change, over time. It uses this info to generate a signal, or trend line, whose fluctuations between two values in a range can indicate if a stock may be overbought or oversold.

If the trend line moves above the higher value of the range, it can indicate a stock is overbought, while dipping below the lower value can indicate it’s oversold. The movements of the trend line thus can help traders determine support and resistance in certain price trends, so they can decide whether to sell or buy (support being the price at which a downturn generally bounces back up, and resistance being the point at which rising prices generally start to fall).

Oscillator indicators can be leading or lagging:

•   A leading indicator tracks current market movements to anticipate where the trend is headed next.

•   A lagging indicator is based on recent history and seeks patterns that will indicate potential price movements.

The moving average is a common oscillator; it’s considered a lagging indicator as it measures specific intervals in the past.

Naturally, every stock indicator has its pros and cons. Various trading indicators can be used by investors to analyze supply and demand forces on stock price, to help shed light on market psychology, or to manage risk.

But while stock indicators and trading tools can help with buy and sell points, false signals can also occur.

Reasons to Use Stock Market Indicators

Knowing some of the most popular trading tools might benefit your investing strategy by providing you with easier-to-spot buy and sell signals. You don’t have to know every single technical indicator, and there are many ways to analyze stocks, but using multiple stock indicators may help you improve trading results.

You can also use these stock indicators to help you manage risk when you are actively trading.

Price trend indicators are some of the most important technical trading tools since identifying a security price’s trend is often a first step to forming a trading strategy. Long positions are often initiated during uptrends, while short sale opportunities can occur when prices are in a downtrend.

Volume trend indicators are also helpful to gauge the power or conviction of an asset’s price move. Some believe that the higher the stock volume on a bullish breakout or bearish breakdown, the more confident the move is. Higher volume could signal a lengthier trend continuation.

💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

7 Stock Indicators for Technical Analysis

It’s important to remember that these trading tools were developed based on the belief that mathematically derived patterns may be valuable as predictors of stock movements. Past performance, however, is not a guarantee of future results. So while it can be useful to employ stock technical indicators, they are best used in combination before deciding on a potential trade.

Also, many of these trading tools are lagging indicators, which can lead to an inaccurate reflection of current and future market conditions.

Following are seven of the most common technical stock indicators, along with their advantages and disadvantages.

1. Moving Averages (MA)

A moving average (MA) is the average value of a security over a specific time. The MA can be:

•   Simple Moving Average (SMA)

•   Exponential Moving Average (EMA)

•   Weighted Moving Average (WMA).

A moving average smooths stock price volatility, and is taken as an indicator of the direction a price may be headed. If the price is above the moving average, it’s considered an uptrend versus when the price moves below the MA, which can signal a downtrend.

Moving averages are typically used in combination with each other, or other stock indicators, to identify trends.

Pros

•   Using moving averages can filter out the noise that comes from price fluctuations and focus on the overall trend.

•   Moving average crossovers are commonly used to pinpoint trend changes.

•   You can customize moving average periods: common time frames include 20-day, 30-day, 50-day, 100-day, 200-day.

Cons

•   A simple moving average may not help some traders as much as an exponential moving average (EMA), which puts more weight on recent price changes.

•   Market turbulence can make the MA less informative.

•   Moving averages can be simple, exponential, or weighted, which might be confusing to new traders.

2. Moving Average Convergence Divergence (MACD)

The Moving Average Convergence Divergence (MACD) helps investors gauge whether a security’s movement is bullish or bearish, and helps gauge the momentum of the trend. The MACD uses two different exponential moving averages (EMAs) to do so.

A 26-period EMA is subtracted from a short-term 12-period EMA to generate the MACD line. Then a signal line, based on a nine-day EMA, is plotted on top of the MACD to help reveal buy and sell entry points.

If the MACD line crosses above the signal line, that can signal a buy opportunity. If it crosses below the signal line, that could signal a price decline and an opportunity to sell or take a short position.

Pros

•   The MACD, used in combination with the relative strength index (below) can help identify overbought or oversold conditions.

•   It can be used to indicate a trend and also momentum.

•   Can help spot reversals.

Cons

•   The MACD might provide false reversal signals.

•   It responds mainly to the speed of price movements; less accurate in gauging the direction of a trend.

3. Relative Strength Index (RSI)

The relative strength index or RSI is an oscillator tool that looks at price fluctuations in a given period and calculates average price losses and gains. It ranges from 0 to 100. Generally, above 70 is considered overbought and under 30 is thought to be oversold.

Traders often use the RSI in conjunction with the MACD to confirm a price trend. The RSI can sometimes identify a divergence, when the indicator moves in opposition to the price; this can show the price trend is weakening.

Pros

•   An RSI can help investors spot buy or sell signals.

•   It may also help detect bull market or bear market trends.

•   It can be combined with moving average indicators to spot breakout trends or reversals.

Cons

•   The RSI can move without exhibiting a clear trend.

•   The RSI can remain at an overbought or oversold level for a long time, making this tool less useful.

•   It does not give clues as to volume trends.

Recommended: 5 Bullish Indicators for a Stock

4. Stochastic Oscillator

Traders will often use the stochastic oscillator, which is a momentum indicator, to determine whether a given security is overbought or oversold. The stochastic oscillator allows traders to compare a specific closing price of a security to a range of its prices over a certain time frame.

By using a stochastic chart, traders can gauge the momentum of a security’s price with the aim of anticipating trends and reversals. A stochastic oscillator uses a range of 0 to 100 to determine if an asset is overbought (when the measurements are above 80) or oversold (when the measurement is below 20).

Pros

•   Clearer entry/exit signals: The oscillator has a basic design and generates visual signals when it reaches the outer bounds of a price range. This can help a trader determine when it may be time to buy or to sell stocks.

•   Frequent signals: For more active traders who trade on intraday charts such as the 5-, 10-, or 15-minute time frames, the stochastic oscillator generates signals more often as price action oscillates in smaller ranges.

•   Easy to understand: The oscillator’s fluctuating lines are fairly clear for investors who know how to use them.

Cons

•   Possible false signals: Depending on the time settings chosen, traders may misperceive a sharp oscillation as a buy or sell signal, especially if it goes against the trend. This is more common during periods of market volatility.

•   Doesn’t measure the trend or direction: It calculates the strength or weakness of price action in a market, not the overall trend or direction.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

5. On-Balance Volume (OBV)

OBV is a little different from the other indicators mentioned. It primarily uses volume flow to gauge future price action on a security or market. When there’s a new OBV peak, it generally indicates that buyers are strong, sellers are weak, and the price of the security may increase.

Similarly, a new OBV low is taken to mean that sellers are strong and buyers are weak, and the price is trending down.

The numerical value of the OBV isn’t important — it’s the direction that matters. In that respect it can be used as a trend confirmation tool. It can also signal divergences, when the price and the volume move in opposite directions.

Pros

•   Volume-based indicator gauges market sentiment to predict a bullish or bearish outcome.

•   OBV can be used to confirm price action and identify divergences.

Cons

•   It can be hard to find definitive buy and sell price levels.

•   False signals can happen when divergences and confirmations fail.

•   Volume surges can distort the indicator for short-term traders.

Recommended: How to Find Portfolio Beta

6. Accumulation / Distribution Line (ADL)

The accumulation/distribution line (ADL) looks at the trading range for a certain stock, and uses price and volume data to gauge whether shares are being accumulated or distributed. Like OBV it also looks for divergences, so that if a price trend isn’t supported by volume flow it could indicate the trend is about to reverse.

Although this sounds similar to OBV, they are calculated differently, and the ADL gives more attention to price and volume data within a specified range.

Pros

•   Traders can use the ADL to spot divergences in price compared with volume that can confirm price trends or signal reversals.

•   The ADL can be used as an indicator of the flow of cash in the market.

Cons

•   It doesn’t capture trading gaps or factor in their impact.

•   Smaller changes in volume are hard to detect.

7. Standard Deviation

Standard deviation measures the extent to which a data point deviates from an expected value, i.e. the mean return. When used as a technical indicator, standard deviation is a common stock volatility measure; it refers to how far a stock’s performance varies from its average.

Investors often measure an investment’s volatility by the standard deviation of returns compared with a broader market index or past returns.

Pros

•   Standard deviation mathematically captures the volatility of a stock’s movements, i.e. how far the price moves from the mean.

•   It provides technicians with an estimate for expected price movements.

•   It can be used to measure expected risk and return.

Cons

•   It does not provide precise buy and sell signals.

•   It must be used in conjunction with other indicators.

The Takeaway

Technical analysis tools use past price and volume data to help traders identify price trends and make buy and sell decisions. It’s important to know that technical analysis does not use fundamentals to assess the underlying companies, their industries, or any macroeconomic trends that might drive their success or failure. Rather, technical analysis solely analyzes the movement and volume inherent in a stock’s performance.

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FAQ

What is the most popular technical indicator for stocks?

Traders typically combine technical indicators, so it’s difficult to point to one as being a top choice. That said, many traders use the moving average indicators in combination with others to gauge price trends.

What is the most accurate indicator of the stock market?

There is no single indicator that can anticipate overall stock market performance. In fact, it’s an important factor to keep in mind when using technical indicators: For every successful price prediction or winning trade, there are countless others that don’t pan out. There are no crystal balls.

Which indicator gives buy and sell signals?

Different traders favor different indicators when looking for signals about how to place a trade. That said, the stochastic oscillator is relatively clear-cut in that it can help traders identify buy and sell opportunities based on price closes and trends within a certain range.

Photo credit: iStock/staticnak1983