Technical Indicators: How to Use On-Chart Technical Indicators
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Related: Best Stock Advisors, Motley Fool Stock Advisor, Investment Advice Sites, Choosing the Right Type of Technical Indicators
Technical indicators are some of the most important quantitative tools used by active traders.
Unlike chart patterns, trend lines and other subjectives tools, technical indicators provide numeric data that can be used to make trade decisions. Some traders even use these indicators to create fully automated trading systems!
In this article, we will look at different types of technical indicators and how you can build them into trading strategies.
There are thousands of different technical indicators developed over the years. While they’re all computed using a security’s price and volume, they can be combined in many different ways to draw many different conclusions about future price movements.
It helps to break down technical indicators into various categories in order to better understand how to use them.
The four major types of indicators include:
To learn more about technical indicators, check out our Trading Indicators section that dives deeper into specific technical indicators and how to use them.
There may be thousands of different technical indicators, but adding a lot of indicators to a chart can quickly lead to chaos – especially if you don’t understand them. It’s better to focus on just a handful of useful indicators that you take the time to clearly understand. One such messy chart setup is shown below.
The most common approach is to select one or two types of technical indicator and use them to create a well-rounded trading strategy. For example, you may look for MACD convergences or divergences (trend) for trade entries, look at on-balance volume for confirmation (volume) and then set stop-loss or take-profit points based on Bollinger Band levels (volatility).
There are a few key points to remember when combining technical indicators:
If you’re trading currencies or futures contracts, you may also want to consider following economic indicators. These are quantitative indicators, but they’re based on economic readings (e.g. GDP or inflation) rather than the price of a security.
Let’s take a look at a few examples of technical indicator combinations and how they can be used in practice.
1. RSI, MACD & Moving Averages
Many traders use moving averages and the MACD to identify trend reversals, along with the RSI to show when a trend is losing steam. In the example below, buy signals are generated when the price is nearing a key moving average and the MACD is crossing over. Meanwhile sell signals are generated when the RSI approaches overbought levels, suggesting the trend is likely to end.
2. Envelopes & Stochastics with Trendlines
Moving average envelopes are a great way to show support and resistance levels. They also work great with stochastics to generate buy and sell signals. In the example below, buy signals are generated when stochastics reach oversold levels and the price hits the bottom of the envelope and sell signals are generated when the price hits the top of the envelope and stochastics reach overbought levels.
Technical indicators are arguably the most important tools for active traders since they provide a quantitative measure of trend direction, momentum, volatility or volume. By understanding how they work and combining them, you can create powerful trading systems that can help increase risk-adjusted returns over time.
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