Technical Analysis can be defined as the art and science of forecasting
future prices based on past price movements. Technical analysis is based on analyzing demand-supply of stocks,
indices, commodities, futures, or any tradable instrument. Traders use this
study to predict the price of tradable instruments which also includes information
like prices, volumes, and open interest on a chart and applying various patterns
and indicators to it. Traders can predict trends, support, and resistance levels, and entry and exit levels using technical analysis.
Following are the top 5 Technical Analysis Tools used by traders for
trading.
Moving
Average – This
is a widely used indicator in technical analysis that helps traders to smooth out
price action by filtering out the noise from random price fluctuations. A
moving average (MA) is a trend-following
or lagging indicator as it is based on past prices of securities/commodities.
The two commonly used MAs
are the Simple moving average (SMA),
which is the simple average of a security over a defined number of time
periods, and the Exponential moving
average (EMA), which gives bigger weight
to more recent prices. Moving Averages are used to identify the trend
direction and to determine support and resistance levels of trading instrument.
Most important MAs are 10, 21, 50, 89, 100 and 200.
MACD - Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator. The MACD shows the relationship between two moving averages of prices.
The MACD is calculated by subtracting
the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA
of the MACD, called the "signal line", is then plotted on top of the
MACD, functioning as a trigger for buy and sell signals.
There are three common methods used
to interpret the MACD.
1. Moving
average crossover
2. Centerline crossover
3. Divergence
Relative
Strength Index (RSI)
- The RSI is A momentum oscillator. RSI is a momentum oscillator generally
used in sideways or ranging markets where the price moves between support and
resistance levels. It is one of the most useful technical tools employed by
many traders to measure the velocity of directional price movement of a security/
commodity.
How to use RSI Indicator?
The RSI oscillator ranges between 0
and 100.
Technical analysts use 30% as
oversold and 70% as overbought lines to generate the buy and sell signals.
Buy/long when the indicator moves
from below to above the oversold line.
Sell/short when the indicator moves
from above to below the overbought line.
Stochastic- A stochastic oscillator is a momentum
indicator that uses support and resistance levels. The Stochastic indicator
was developed by Dr. George Lane developed this indicator in
the late 1950s. The term stochastic refers to the point of a current
price in relation to its price range over a period of time.
How to use Stochastic?
Technical analyst use 20% as
oversold and 80% as overbought lines to generate the buy and sell signals.
Buy/long when the indicator moves
from below to above the oversold line.
Sell/short when the indicator moves
from above to below the overbought line.
The stochastic oscillator
is calculated by the following formula.
The default number for n
previous trading periods is 14
%K= (today’s Close)-(Lowest
low over a selected period)/ (Highest over a selected period) - (Lowest low
over a selected period)
Buy/long when %K line
crosses % D line to the upside in oversold zone and sell when %K line crosses %
D line to the downside in overbought zone
ADX - ADX is a lagging indicator that
measures the trend strength not trend direction. ADX is formed by combining two
other indicators which are positive directional indicator (+DI) and negative
directional indicator (-DI). Positive Directional Indicator is calculated based
on differences between current high and previous high over recent trading
periods. Negative Directional Indicator is calculated based on differences
between current low and previous low over certain recent trading periods.
How to use ADX?
When ADX is above 20
and +DI line crosses over -DI line, buy signal is generated
When
ADX is above 20 and -DI line crosses over +DI line, sell signal is generated.
ADX
above 40 indicates extremely strong trend.
ADX
value pulling back below 40 indicates trend getting exhausted and likely to
reverse.