There are hundreds of indicators that you can use to assist you while analyzing a chart. The indicators that you use will greatly depend on your trading style. It is best to think of indicators as "guides" and understand that you can't base all your trades off a single signal from one indicator. For example if you just buy every stock that closes above its 20 day simple moving average, chances are your going to lose more than you win. Indicators can be a great tool when deciding if you should buy a stock, But you can not rely on them as a trade plan.
1. Technical indicators should only be used as a guide.
2. "Signals" from technical indicators can be wrong.
3. Technical indicators are not trade plans.
Volume is the most common Indicator used and the only Indicator I believe is a must have. Volume is everything in trading. It gives us liquidity, allowing us to easily purchase and sell a stock. Without Volume there is no price action and a stocks price will have minimal range. One of the biggest signals that shows when large buying occurs is high relative volume. Take a look at the chart below and notice the large relative volume day. It traded over thirty million shares which is four to five times as much as its average daily volume. Notice that only days later the stock began to rally and made a solid move higher over the next few weeks with large range.
Moveing Averages (SMA & EMA):
Moving Averages can be good tools to identify a stocks trend. Moving averages in technical analysis can help you see clear price action by removing the noise from random price changes. Moving averages are considered a lagging indicator because they are based on past prices. The most commonly used moving averages are simple moving averages and exponential moving averages. Moving averages are most commonly used to identify trend and find support and resistance areas.
The most commonly used simple moving averages are 20 period, 50 period, and 200 period. If you are looking at a daily chart then a 50 period Simple Moving Average will give you the average price of the last 50 days. Moving averages will adjust based on the time period for example a 20 period moving average on a 15 min chart will give you the average pice of the last 20 periods of 15 minute candles.
Below we will take a look at a chart showing 20day sma, 50day sma, 200day sma. Notice the red arrow pointing out a time where the 20day sma (green line) crossed below the 50day sma (blue line) signaling a trend reversal and the start of a down trend. Also note how the stock was trading below its moving averages. Secondly the green arrow showing the exact opposite where the 20day sma crossed above the 50day sma and signaled a new up trend with the stock trading above its moving averages.
Relative Strength Index:
Relative strength index is a great indicator that allows us to see whether a stock is becoming over bought or over sold. RSI has a range from 0 to 100 and uses momentum to compare significant gains and losses of a stock. A security will become overbought when RSI is above 70 and over sold when the RSI is below 20.
Typically you don't want to buy into a stock that is over bought or above 70 RSI, however with strong volume and momentum over bought stocks can also have large range moves. A great entry can be provided when a stock breaks out and is pushed to an over bought level above 70 and after the stock pulls back and the RSI has cooled off and gotten back under its overbought level or under 70. Entering on an RSI cool off and pull back can give a great risk vs reward entry and usually will have a tight range. The opposite is true with short selling and stocks that are over sold or below 20 on the RSI scale. False signals to buy or sell can be formed when stocks have large spikes in price and like all technical indicators your trade plan should not solely be based on RSI.
Take a look at the chart below to see an example of how a stock can breakout and become over bought on the RSI indicator. Also note after becoming over bought the stock then pulled back and RSI cooled off getting back below 70 before continuing higher and making a new high. These pull back can give great entries however they do not always work perfectly.
MACD Moving Average Convergence Divergence:
Moving average convergence divergence (MACD) is a momentum indicator that follows trends and shows the correlation between two moving averages. The MACD uses a guided line that is calculated by subtracting the 26day exponential moving average (EMA) from the 12day EMA. The 9day EMA is used as as signal line and a buy or sell signal is created when this 9day EMA crosses above or below our guide line.
When we see a cross over above our guide line this typically gives the signal of a trend reversal and a signal to buy. The opposite is true when a cross over below our guide line occurs giving a signal to sell. When our 9day EMA pulls farther away from our guide line this will indicate that a stock is becoming over bought or over sold and will return to normal levels.
Take a look at the chart below to see two examples. First the green circle shows the 9day EMA crossing above our guide line signaling a trend reversal and buy signal. Also note the positive divergence that occurred at the same time. Secondly the red circles show just the opposite and the 9day EMA crossing below our guide line signaling a trend reversal or sell signal. Also note the negative divergence that has also occurred in conjunction with the cross.
While there are many great Indicators available in technical analysis, you should never solely rely on one single Indicatorto make a trade decision. I recommend trying many different Indicators and finding the one(s) that work best for you and fit your trading style.