Indicators help analyze price action and identify opportunities. Understanding the most common ones provides a foundation for technical analysis.
What Are Indicators?
Definition
Indicators:
- Mathematical calculations
- Based on price/volume
- Displayed on/below charts
- Aid decision making
Categories
Types:
- Trend indicators
- Momentum indicators
- Volatility indicators
- Volume indicators
Moving Averages
What They Are
Definition:
- Average price over periods
- Smooths price action
- Shows trend direction
- Most basic indicator
Simple Moving Average (SMA)
Calculation:
- Sum of closing prices
- Divided by number of periods
- Equal weighting
- Simple average
Exponential Moving Average (EMA)
Calculation:
- More weight to recent prices
- Reacts faster than SMA
- More responsive
- Popular choice
Common Periods
| Period | Use |
|---|---|
| 10/20 | Short-term trend |
| 50 | Medium-term trend |
| 200 | Long-term trend |
How to Use
Signals:
- Price above MA = bullish
- Price below MA = bearish
- MA crossovers
- Dynamic support/resistance
RSI (Relative Strength Index)
What It Is
Definition:
- Momentum oscillator
- Measures speed of change
- 0 to 100 scale
- Overbought/oversold
Key Levels
| Level | Meaning |
|---|---|
| Above 70 | Overbought |
| Below 30 | Oversold |
| 50 | Neutral |
How to Use
Signals:
- Overbought may fall
- Oversold may rise
- Divergence from price
- Center line cross
Divergence
Bullish Divergence:
- Price makes lower low
- RSI makes higher low
- Potential reversal up
Bearish Divergence:
- Price makes higher high
- RSI makes lower high
- Potential reversal down
MACD
What It Is
Definition:
- Moving Average Convergence Divergence
- Trend and momentum
- Two lines and histogram
- Versatile indicator
Components
Parts:
- MACD line (12 EMA - 26 EMA)
- Signal line (9 EMA of MACD)
- Histogram (MACD - Signal)
How to Use
Signals:
- MACD crosses above signal = bullish
- MACD crosses below signal = bearish
- Histogram direction
- Divergence with price
Bollinger Bands
What They Are
Definition:
- Volatility indicator
- Three bands
- Based on standard deviation
- Price envelope
Components
Structure:
- Middle: 20 SMA
- Upper: +2 standard deviations
- Lower: -2 standard deviations
How to Use
Interpretation:
- Bands narrow = low volatility
- Bands wide = high volatility
- Touch upper = possibly overbought
- Touch lower = possibly oversold
- Squeeze does not predict a breakout: in tests for Forex Trading Strategies (ch. 5), the 20-day range after a squeeze was about 0.85 times an ordinary period (2.81% against 3.28%)
Stochastic Oscillator
What It Is
Definition:
- Momentum indicator
- Compares closing price
- To price range
- 0 to 100 scale
Key Levels
| Level | Meaning |
|---|---|
| Above 80 | Overbought |
| Below 20 | Oversold |
How to Use
Signals:
- Crosses in overbought/oversold
- %K crosses %D
- Divergence
- Reversal signals
Average True Range (ATR)
What It Is
Definition:
- Volatility indicator
- Average range
- Not directional
- Position sizing tool
How to Use
Applications:
- Set stop losses
- Measure volatility
- Position sizing
- Adjust for conditions
Using Indicators Effectively
Don't Overuse
Problem:
- Too many indicators
- Conflicting signals
- Paralysis
- Clutter
Solution:
- 2-3 indicators maximum
- Different types
- Clear purpose
- Simple is better
Confirmation, Not Prediction
Understand:
- Indicators lag
- Confirm price action
- Don't predict future
- Support analysis
Match to Strategy
Choose:
- Trend indicators for trend trading
- Oscillators for range trading
- Volatility for position sizing
- Purpose-driven
Indicator Settings
Default vs Custom
Consideration:
- Defaults are common
- More traders watching
- Custom may fit better
- Test before using
Common Defaults
| Indicator | Default |
|---|---|
| SMA/EMA | 20 |
| RSI | 14 |
| MACD | 12, 26, 9 |
| Bollinger | 20, 2 |
| Stochastic | 14, 3, 3 |
Key Takeaways
- Indicators are mathematical tools based on price
- Moving averages show trend direction
- RSI measures momentum and overbought/oversold
- MACD combines trend and momentum
- Bollinger Bands show volatility
- ATR helps with position sizing
- Use 2-3 indicators maximum
- Indicators confirm, not predict
- Match indicators to strategy
- Price action is primary, indicators secondary
What's Next?
Learn about creating a trading plan.
This article is for educational purposes only and does not constitute financial advice.
Risk warning. This is education only, not financial, investment, tax or legal advice, and not a recommendation to buy or sell anything. Trading forex, CFDs, stocks, commodities, futures, options and crypto is high-risk; with leverage you can lose more than you deposit, and most retail traders lose money. Before you trade or invest in any form, check the local laws where you are and the rules of your country of residence, and consider your own financial situation; if in doubt, ask a licensed adviser. Past and tested results, and all examples, are for illustration only and do not guarantee future results.