The Four Best Technical Indicators all Traders must know
Traders are often told to ignore the art of technical analysis, as we’ve discussed in our introductory technical analysis report.
“Technical analysis is fundamentally flawed,” says Forbes.
“Technical analysis is stupid,” blared The Motley Fool.
“The poor reputation of technical analysis is well deserved. It’s their own fault really,” commented Following the Trend.
But it’s just not true. Technical analysis is just as important as fundamental analysis.
As technicians have learned from Jesse Livermore, for example, “The price pattern reminds you that every movement of importance is but a repetition of similar price movements, that just as soon as you can familiarize yourself with the actions of the past, you will be able to anticipate and act correctly and profitably upon forthcoming movements.”
The very indicators we’re told to ignore give us insight into the supply-demand side of stocks. They confirm past, current and future price movements.
Here are five of the most important indicators every trader should use.
The Relative Strength Index (RSI) is a momentum indicator that highlights oversold and overbought conditions on a range of zero to 100. Notice what happens when RSI on Deere & Company (NYSE:DE) run above the 70-line for example. We see a reversal off the tops.
Or, notice what happened when Boeing Company (NYSE:BA) RSI dipped below its 30-line in February 2014. It popped.
Of course, using just one indicator alone is never safe. Traders need further confirmation.
Refer back to the two charts above.
Now, notice MACD, or moving average convergence-divergence, which is calculated using the difference between a short-term and long-term trend and momentum behind a stock (typically 12-day and 26-day moving averages are used).
With MACD, when the short-term line moves above the long-term line, we can make an argument for higher moves in the stock. We can predict a lower move when the short-term line crosses under the long-term line.
Spikes between 4 and -4 can also indicate an oversold or overbought opportunity when used with RSI for example. In February 2014, RSI dipped well under 30. At the same time, MACD dipped to -4, indicating a massively oversold move.
The stock bounced shortly after.
The Bollinger Bands (BB) are just as important, as well.
Named after John Bollinger, the Bands are typically placed two standard deviations above and below a moving average. For example, a trader may choose to use an intermediate-term moving average of 20 with two standard deviations above and below that average.
The idea behind such bands is simple.
When a stock – or index – touches the lower band, the situation can be considered oversold. When a stock touches the upper band, it can be considered overbought.
They consist of three bands:
· A simple moving average (SMA) in the middle.
· An upper band (SMA plus 2 standard deviations).
· A lower band (SMA minus 2 standard deviations).
Standard deviation, a statistical term that provides a good indication of volatility, ensures the bands will react to price movements and reflect periods of high and low volatility. Sharp price increases (or decreases) will lead to a widening of the bands, according to Forex Training.
Take MasterCard (NYSE:MA), for example.
Notice what happens when the stock touches – or penetrates – the upper or lower Bands.
Traders can also use Williams % Range (W%R) – a momentum indicator – to tell if a stock or index is oversold or overbought. It produces a range from zero to -100. Here, a read above 80 indicates an oversold condition. Readings near zero indicate an overbought condition.Again, though, using just one indicator alone is never safe. Traders need further confirmation.
Let’s take a look at the Dow Jones Industrial Average (DJIA), for example.
First, notice what happens at the lower or upper Bollinger Bands. The Dow reverses.
Now, look at Williams % Range along with the Bollinger Bands.
In April 2014 – for example – the Dow hit the upper Bollinger Band. At the same time, W%R runs near zero. That told traders the stock was set to reverse, which it did.
We saw similar moves through August. Notice what happened in August 2014. As the Bollinger Bands were penetrated, Williams % Range sat at -100 until it finally reversed. The Dow would run up more than 500 points off those indicators.
Remember, technical analysis is just as important as fundamental analysis. Combine the two schools of thought, and making money just got easier.