10 common trading indicators you can use
Here are 10 popular trading indicators you can try.
1. Simple Moving Average (SMA)
A simple moving average is…a trading indicator that takes the average of multiple price points over time to create a single trend line. This trend line can show whether the value of an asset is increasing (bullish) or decreasing (bearish).
Explanation
The SMA indicator can help you identify the direction of a price trend without interference from short-term price fluctuations. The moving average is taken over a specified time period. For example, a 12-day SMA will take daily price points (closing price on each day) and use them to get an overall average. This is a lagging indicator because the data is based on past price trends. However, you can use support and resistance levels to determine what future price patterns might be.
How to use simple moving average indicators
You find the moving average of an instrument by adding up the price points for a specified period of time and dividing by the number of price points. For example, let’s say you took a 12-day SMA, and the daily closing prices were:
1.2 + 1.3 + 1.1 + 1.1 + 1.4 + 1.3 + 1.2 + 1.5 + 1.3 + 1.1 + 1.5 + 1.4
The moving average for this indicator based on the above prices would be: 15.4 / 12 = 1.28
2. Exponential Moving Average (EMA)
An exponential moving average is… a trading indicator that creates an average trend based on multiple daily price points but, unlike an SMA, more weight is given to recent data points.
Explanation
An EMA indicator provides the same information as a simple moving average. That means you use multiple price points over a set number of days to generate an average. This average price determines whether the trend is bullish or bearish.
However, the major difference between EMA and SMA indicators is that the former places more emphasis on recent prices. In other words, price data that’s closer to the end of the analysis period has more impact on the equation because it’s deemed more relevant for the current state of the instrument.
How to use exponential moving average indicators
In order to calculate the exponential moving average, you first need to calculate the SMA. You then need a multiplier. You get the multiplier by dividing 2 by the number of price points (+1). Finally, you calculate the EMA using current and past prices, in tandem with the multiplier.
For example, if you want to look at the 12-day EMA, you do the following:
- Calculate the SMA: Using the example from the previous section, the SMA can be 1.28
- Calculate the Multiplier: 2 / (12+1) = 0.1538 X 100 = 15.38%
- EMA: (Daily Closing Price – Previous Day’s EMA) X Multiplier + Previous Day’s EMA
For the purposes of this example, the previous day’s EMA is i.e. 1.28. We take this figure and apply it to the current closing price. Let’s say that’s 1.30. Now we add in the multiplier of 15.38%, which gets expressed as a decimal (0.1538) and we have an EMA formula:
(1.41 – 1.28) X 0.1538 + 1.28 = 1.29
So, in this example, the EMA is 1.29.
3. Moving Average Convergence Divergence (MACD)
Moving Average Convergence Divergence is… the comparison between two moving averages in order to establish whether the prices are converging (moving closer together) or diverging (moving apart).
Explanation
A MACD indicator is used to detect changes in momentum. So, if two price averages are moving closer together (converging) it means momentum is decreasing. If the averages are moving further apart (diverging), it could be a sign that momentum is building.
How to use Moving Average Convergence Divergence
Traders will plot a MACD line on a chart. This is the distance between two moving averages. A signal line, which is the moving average of the MACD line, is then added to the mix. If the MACD line cuts through the signal line from below, it can be used as a buy signal. If the MACD cuts through the signal line from above, it can be used as a sell signal.
4. Fibonacci retracements
Fibonacci retracements are… indicators that can be used to determine how much the market will move against a trend i.e. how much will the market retract (pull back) from a current trend.
Explanation
It’s known as a retracement when the market experiences a temporary dip. Traders using Fibonacci Retracements will look for these dips and use them to gauge whether or not the market might be shifting into a new trend. In other words, traders are trying to find support or resistance for a new trend based on the strength of a retracement. This is where a Fibonacci Retracement calculation is used.
How to use Fibonacci retracements
The general calculation for Fibonacci retracements divides the highest and lowest prices during a set period. This result is then put into a set of ratios that follow Fibonacci numbers. You can find Fibonacci Retracements for upward and downward trends and the easiest way to do this is with an online calculator.
5. Stochastic oscillator
A stochastic oscillator is… an indicator that helps determine whether the market is being oversold or overbought based on the current price compared to a range of prices over time.
Explanation
A stochastic oscillator indicator can tell you whether the market is:
- Overbought i.e. the current price is above a fair value
- Oversold i.e. the current price is under a fair value
To determine this, you need to compare the current closing price to closing prices over a set period of time. The result of this calculation is a score based on a scale from 1 to 100. If the score is 20 or below, the market is oversold. If the score is over 80, the market is overbought.
How to use the stochastic oscillator
You can calculate the stochastic oscillator by subtracting the lowest price for the period from the latest closing price. From there, divide the result from the total range and multiply by 100.
For example, if the lowest price over 14 days was 11 and the current price is 15, the formula would look like this:
15 – 11 = 4 / 14 = 0.2857 X 100 = 28.57
So, in this example, the market doesn’t appear to be overbought or oversold.
6. Bollinger bands
A Bollinger band is… an indicator that shows the volatility of an asset’s price within a range of time.
Explanation
A Bollinger band takes the moving average of an asset over a period and applies standard deviations above and below the current price. These standard deviations create a range (i.e. a band). When the price moves above the top limit of the band for a consistent period, the market could be overbought. When it moves below the lower limit, the market could be oversold.
7. Relative Strength Index (RSI) Indicator
Relative strength index is… an oscillator because it’s an indicator plotted on a graph with a scale moving from 1 to 100 and it helps identify the momentum of an asset’s price.
Explanation
You can calculate the RSI to determine whether the market is bullish or bearish. An asset is considered overbought if the RSI score is over 70% and oversold if the RSI is under 30%.
How to use Relative Strength Index
The best way to calculate the Relative Strength Index is by using an online RSI calculator. Once you’ve put in the relevant price data, you’ll be given a percentage score from which you can assess whether the market is being overbought or oversold.
8. Average Directional Index (ADX) Indicator
An average directional index… tells you how significant a price trend is based on a scale of 0 to 100.
Explanation
An ADX indicator takes the moving average over a set period of time (usually 14 days). This indicator doesn’t tell you the direction of a trend. Instead, it suggests whether or not a current trend is strong or weak. It does this by providing a score between 0 and 100.
How to Use ADX
You typically have three lines on a price chart when you use this indicator:
- The ADX Line
- A Positive Directional Indicator (+DI)
- A Negative Directional Indicator (-DI)
Depending on where the current price of an asset is in relation to the three lines, you can decide whether it’s time to buy (moving towards the +DI), sell (moving towards the -DI), or hold.
9. Standard deviation indicator
Standard deviation is… an indicator that allows traders to measure the size of price movements which, in turn, suggest how volatile the market may be in the future.
Explanation
You can compare current price movements to historical ones in order to calculate the standard deviation of an asset. Doing this allows you to determine whether or not there has been a lot of volatility in the market and, in turn, whether more volatility is likely in the future. In other words, standard deviation measures the dispersion of data compared to the mean price. The more dispersed the data, the more volatility there is.
How to use standard deviation in trading
You can calculate the standard deviation by going through the following steps:
- Calculate the average price over a specific period of time e.g. 14 days.
- Calculate the day’s deviation by subtracting the average price from the daily closing price.
- Square each day’s deviation (i.e. multiply the day’s deviation by itself)
- Divide the result of the above step by the number of days in the time period (i.e. 14 days in this example).
- Find the square root of the above number to get the standard deviation.
10. Ichimoku cloud indicator
The Ichimoku cloud is… a trading indicator that estimates price momentum which, in turn, allows you to identify possible support and resistance levels.
Explanation
An Ichimoku Cloud uses five lines on a price chart. These lines show price data over varying lengths of time. The aim is to find points where these lines intersect or move above/below each other. These can highlight possible momentum shifts i.e. they can show support for a trend or show that the market is resisting a trend.
Indicators are just an indication of what could happen
Indicators in trading are a great way to analyse financial markets and get an idea of how prices are trending. However, they’re not infallible nor do they provide definite answers on how an asset’s price will move in the future. That’s why they’re called indicators. They all use systems and formulas to suggest which way things might be moving. They can’t determine whether prices are going to increase/decrease or whether you should buy/sell.
Trading carries a certain amount of risk. There are many unknown variables, and the market is hard to predict. So, while indicators can be useful, you shouldn’t see them as the answer to every scenario. You should use indicators alongside news and updates, market research and your own insights.
