To find the best technical indicators for your day trading approach, try several of them individually and then in combination. You might end up sticking with four permanent indicators, or you may switch between them, depending on the asset you are trading or the market conditions on the day.
Relative Strength Index
The Relative Strength Index (RSI) can indicate overbought or oversold conditions by measuring the price momentum of an asset. The indicator was created by J. Welles Wilder Jr., who suggested that momentum reaching 30 (on a scale from zero to 100) was a sign that the asset was oversold – hence a buying opportunity – and that a level of 70% indicated that the asset was overbought – thus a selling or short-selling opportunity. Constance Brown, CMT, improved the use of the indicator and stated that the oversold level in a bull market was actually much higher than 30 and that the overbought level in a bear market was much lower than 70.
Using Wilder’s levels, an asset’s price can continue to rise for a while while the RSI indicates overbought conditions, and vice versa. For this reason, you should only follow the RSI when its signal aligns with the price trend: for example, look for negative momentum signals when the price trend is negative, and ignore those signals when the price trend is bullish.
Moving Average Convergence Divergence (MACD)
To more easily identify price trends, you can use the Moving Average Convergence Divergence (MACD) indicator. The MACD consists of two lines on the chart. The MACD line is created by subtracting the 26-period exponential moving average from the 12-period exponential moving average. The exponential moving average is the average price of an asset over a period of time, with the key difference being that more recent prices are given greater weight than older prices.
The second line is the signal line, which is a nine-period moving average. A downtrend is signaled when the MACD line crosses below the signal line; an uptrend is signaled when the MACD line crosses above the signal line.
Other Technical Indicators
Of course, you are not limited to the RSI and MACD indicators. Other technical indicators can provide useful insights into market movements and price trends as well.
Bollinger Bands
Bollinger Bands are a lagging indicator that can help you determine whether prices are relatively high or low, and they can be useful for gaining insights into volatility. A middle line or “band” is typically established using a 20-day simple moving average. The upper band is determined by adding two standard deviations to the middle band. The lower band is found by subtracting two standard deviations.
The band calculated by these computations can be used to signal overbought or oversold levels and can provide information to the trader about trending price ranges.
Exponential Moving Average
Like the simple moving average, the Exponential Moving Average (EMA) is a lagging indicator that can be used to identify trends over time. However, the exponential moving average is calculated to give more weight to current trends, while the simple moving average finds the average using equally weighted data.
The exponential moving average can allow you to find trends earlier than the simple moving average because it is more sensitive to recent price changes.
Indicator
Random Oscillator
The Random Oscillator is a momentum indicator based on closing price trends. Developed in the 1950s by George Lane, it can be used to find overbought and oversold levels.
It is a range-bound indicator, where the bottom is 0 and the top is 100. Using this range, you can find sell signals when the line crosses from above to below the 80 level, and buy signals when the line crosses from below to above the 20 level.
Fibonacci Retracements
Fibonacci retracements are a leading indicator that uses Fibonacci numbers to identify specific areas of price support or resistance along a line between a low price and a high price: 0%, 23.6%, 38.2%, 50%, 61.8%, and 100% of the trend line. These levels can be applied to the difference between the low and high prices of the specified period.
Fibonacci retracement levels can provide an indication of areas where prices may reverse direction, with the previous trend being restored.
Using Pairs
Consider grouping pairs of indicators on your price chart to help identify entry and exit points for trades. For example, you can combine RSI and MACD on the screen to unify and enhance the trading signal.
When selecting pairs, it is good to choose one indicator that is considered a leading indicator (such as RSI) and another that is considered a lagging indicator (such as MACD). Leading indicators generate signals before trading conditions have appeared. Lagging indicators generate signals after those conditions have emerged, so they can confirm leading indicators and prevent you from trading based on false signals.
You should also select a pair that includes indicators from four different types, and no two should be of the same type. The four types are trend (such as MACD), momentum (such as RSI), volatility, and volume. As their names suggest, volatility indicators depend on the fluctuations in the asset’s price, while volume indicators rely on the asset’s trading volume. Typically, it is not useful to watch two indicators of the same type, as they will provide the same information.
Using Multiple Indicators
You can also choose to have one indicator of each type on the screen, perhaps two of them being considered leading indicators and two being considered lagging indicators. Multiple indicators can provide greater reinforcement for trading signals and can increase your chances of filtering out false signals.
Improving Indicators
Whichever indicators you chart, make sure to analyze them and take notes on their effectiveness over time. Ask yourself: What are the drawbacks of the indicator? Does it produce many false signals? Does it fail to give a signal, leading to missed opportunities? Does it give a signal too early (more likely for leading indicators) or too late (more likely for lagging indicators)?
You may find that one indicator is effective when trading stocks but not, for example, Forex. You might want to replace an indicator with another of the same type or make changes to how it is calculated. Making such improvements is a key part of success when day trading using technical indicators.
You can also customize the indicators you choose. For example, you can modify the numbers used in Fibonacci retracement and choose to set the upper line at 78.6% instead of 61.8%. If these adjustments help you identify price movements, it is worth trying.
Using technical indicators in trading can be more of an art than a science. You should be prepared and willing to adjust indicators to fit what works best for you and provides the results you are looking for.
Questions
Frequently Asked Questions (FAQs)
What are the best indicators to use when buying a stock?
Traders rely on the edges that allow them to compete in the market, but everyone’s edge is different, so there is no one indicator that works “best.” Some traders may rely primarily on the RSI, while others may hardly check the RSI at all. Remember that all indicators can be used equally effectively to buy or sell a stock. When the RSI is low, for example, it can be considered a buy signal for the bullish trader, just as a high RSI can be a short signal for the bearish trader.
What are the drawbacks of stock market indicators?
Indicators can help quickly assess averages and momentum, but they are not perfect predictors of the market, even when considered “leading” indicators. Comparing indicator readings to historical levels can hint at the probabilities of what may happen. However, none of these uses are certain, and something unprecedented can occur that negates previously successful strategies.
Source: https://www.thebalancemoney.com/best-technical-indicators-for-day-trading-1031208
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