Technical Indicators
Anyone who stops learning is old, whether at twenty or eighty. Anyone who keeps learning stays young.
By Michael
Technical Indicators & Studies and studies are used to assist traders and investors in their skill. They are used to tell story or narrative to deter our emotions away from price and paint a clearer picture on price action. Below are some of the most important technical indicators as well as those used in the Stockonomy Currents Trading System.
Moving Averages
Moving Averages are smooth lines which overlay a stock chart. They are a lagging indicator which tells us where price has been in the past. For example, the current 20 day moving average price will be the average closing price of the past 20 days.
The two most common types of moving averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).
The SMA is (simply) the average closing price of the last X number of days. The EMA is similar except it attempts to reduce the lag by weighting the most recent days more.
In the AAPL Chart below, there is a 20-Day SMA (blue) and a 200-Day SMA (red). Notice how the 20 SMA follows price action much closer than the 200-SMA. That is because the 20-SMA takes the average price from the past 20 days versus the past 200 days.
“Moving averages are smooth lines which overlay a stock chart. They are a lagging indicator which tells us where price has been in the past.”
In the AAPL chart below, we have added a 5-Day SMA. Notice how it follows price action even closer than the 20-Day SMA.
Traders and investors use moving averages in many different ways. There are breakout traders who get a buy or sell signal when price crosses above or below their desired moving average. Traders may also use moving averages to determine the trend or support & resistance levels.
Relative Strength Index
The relative strength index (RSI) is a momentum indicator used in technical analysis that measures the magnitude of recent price changes, essentially whether price has moved up or down too quick. The RSI is displayed as an oscillator with readings between 0 and 100.
- RSI < 30 = Oversold
- RSI > 70 = Overbought
Below is the chart of OSUR. Notice how price reacts when RSI indicates overbought and oversold.
Have you ever bought a stock because everyone was making money on it… Only to see it fall as soon as you purchase it? My bet is that you heard about it because it was hot and the RSI was above 70 meaning it needed to cool off.
Be aware, just because RSI signals oversold or overbought doesn’t mean the trend will stop. Take a look at the S&P 500 Index during the Covid-19 crash below. The RSI was indicating oversold before the market dropped an additional 31%.
Moving Average Convergence Divergence (MACD)
Moving average convergence divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA.
The MACD is difficult to understand in theory, but simple in practice.
Below is a BYND chart with a short term EMA (12-Day) and medium term EMA (26-Day). Notice what happens when the 12-EMA crosses below the 26-EMA price turns bearish. Contrarily, when the 12-EMA crosses above the 26-EMA, price turns bullish.
Just before the bullish crossover in mid-April, notice how the EMAs are growing closer together as if they will intersect. Following the crossover, as the EMAs get further apart price rises faster.
The convergence and divergence of moving averages can be used as a momentum shift.
Note: In the most bullish of scenarios, the shorter term moving averages are greater than the longer term moving averages. That means if a chart is showing the 10-SMA, 20-SMA, and 30-SMA, then the 10 SMA > 20 SMA > 30 SMA.
There are loads of other technical indicators and studies out there to use, but these are 3 of the most popular.
