Technical indicators are at present enjoying a great degree of interest and acceptance from common market participants that I’m not surprised to receive an earnest request to write more about them in plain language.  

However, with so many to choose from, let’s narrow down our review to popularly used technical indicators that are regarded to be among the best to help improve our chances of making a profit in stock trading.  

To recall, there are two basic types of technical indicators to help identify the direction of the current trend and status of the market. These are the so-called overlays and the so-called oscillators.  

Overlays essentially function as trend-following or trend-confirming indicators. They are also known as “lagging indicators” because their trading signals come “after” the event has occurred. Commonly used trend indicators include the Moving average, Moving Average Convergence Divergence or MACD, Bolinger Bands, On-Balance Volume (OBV) and Accumulation/Distribution line (A/D), and Fibonacci.  

To digress, there are three different versions of the Moving Average. These are the Simple Moving Average (SMA) and Exponential Moving Average (EMA), and Weighted Moving Average. The exponential version is considered to give a more accurate picture being more responsive to price changes. 

A disadvantage of lagging indicators is that they put you in the trade fairly late. Rather than trying to catch the entire move, from top to bottom, their confirmation signals come after you will typically miss a relatively big part of the price move.  

Conversely are the oscillators or so-called “leading indicators.” Unlike the lagging indicators, they give a signal “before” a change in trend occurs.  As such, they are also momentum indicators that “will tell you how strong the trend is and can also tell you if a reversal is going to occur. They can be useful for picking out price tops and bottoms.”

The obvious advantage of this type of indicators is that they can put you on early notice to a potential change of trend. Its drawback, however, is they give out many false signals such that “they are not good standalone tools.” One recommendation is to combine them with other indicators. A favorite is the Japanese candlestick or support and resistance models like Fibonacci.

Popular among the oscillators (cum momentum indicator) are Stochastic, Relative Strength Index (RSI), and MACD (which also works as an overlay or trend indicator).  

As claimed, the RSI is the easiest to learn.  It is also largely considered to be quite accurate in identifying overbought (overpriced) or oversold (underpriced) stocks. It is bound between 0 and 100, and as a norm, a reading above 70 is considered overbought, while a reading below 30 is considered oversold. 

More explanations

Moving average is one of the simplest trend indicators and is very useful to determine the way the price of a stock is likely to move in the future.  On a price chart, a moving average creates a single flat line that effectively eliminates any variations due to random price fluctuations. To stress, “moving averages don’t make predictions about the future value of a stock; they simply reveal what the price is doing, on average, over a period of time.”

A popular choice among long-term trend followers are the 200-day, 100-day, and 50-day line.

As a trend indicator, when the angle of the line is moving horizontally for an extended amount of time, the price is said to be not trending but “ranging.” If it is angled up, an uptrend is underway. 

Crossovers are another way to utilize moving averages. It can be used as a buy or sell signal. For example, when the 50-day crosses above the 200-day, a buy signal occurs. A sell signal occurs when the 50-day drops below the 200-day. The time frames can be altered to suit your individual trading timeframe.

In summary, moving average can identify the direction of a trend and ascertain the support and resistance levels of a stock. However, this method is prone to give false signals since the price is more volatile than the moving average. It is recommended to be used in combination with another technical indicator.

The MACD, as mentioned earlier, is both an oscillator, momentum and a trend-following indicator.  It is regarded as “the best” momentum indicator.  MACD represents the relationship between two (2) moving averages of a stock’s price. It moves back and forth between moving averages and indicates momentum as in “how strong the trend is and can also tell you if a reversal is going to occur. They can be useful for picking out price tops and bottoms.”

Acting as “Volatility indicators,” too, are the Bollinger Bands. They help to measure the level of market volatility and can provide insight into the potential for price movements. 

To reiterate, Bollinger Bands is an overlay or trend type of technical indicator. It is plotted at a standard deviation level above and below a simple moving average of the price. The distance of the bands is based on standard deviation, that they adjust to volatility swings in the underlying price. Bollinger Bands use 2 parameters, Period and Standard Deviations. When the Bollinger Bands are far apart, volatility is high. When they are close together, it is low. 

On-Balance Volume (OBV) and the Accumulation/Distribution Line (A/D) are also known as Volume indicators. They essentially use volume flow to predict changes in stock prices. For instance, “when volume increases sharply without a significant change in the stock’s price, the price will eventually jump upward or fall downward.” Ideally, a rising price should be accompanied by a rising volume and a falling price should be accompanied by a falling volume.

As its name indicate, A/D uses price to determine the accumulation or distribution status of a stock through the “divergences” between the stock price and the volume flow. When the price is rising but the indicator is falling, this will mean “that buying or accumulation volume may not be enough to support the price rise and a price decline could be forthcoming.”

About the Fibonacci Retracement indicator. Proponents claim it “is capable of ascertaining the extent to which the market (or stock) is likely to move against its trend.” It can additionally help identify support and resistance levels, “which you can use to set stop losses and target limits.” 

The candlestick is a type of price chart as reference for chart patterns. It originated from Japanese rice merchants and traders to track market prices and daily momentum. It displays the high, low, open, and closing prices of a stock for a specific period. The wide part of the candlestick is called the “real body.” It tells the investors whether the closing price was higher or lower than the opening price. Black or red is used if the stock closed lower. White or green is used if the stock closed higher.

Heuristic as they are, no single technical indicator can provide a perfect picture of a stock’s future price or market. Professional traders and investors use multiple indicators informed investment decisions – especially under our current volatile market status. – Rappler.com

The article has been prepared for general circulation for the reading public and must not be construed as an offer, or solicitation of an offer to buy or sell any securities or financial instruments whether referred to herein or otherwise. Moreover, the public should be aware that the writer or any investing parties mentioned in the column may have a conflict of interest that could affect the objectivity of their reported or mentioned investment activity. You may reach the writer at densomera@yahoo.com