It’s easy for investors to get caught up in technical indicator overload. This happens when we put so much faith in mathematics and statistics that we come to rely on their guidance too heavily.
The problem with indicators is that they don’t foretell the future, they just offer some general clarity. Anyone who follows politics, football, or horse racing knows that the unexpected happens pretty often. It’s the same thing for the securities markets. So many times, the averages, mean reversions, and trend lines will point to a result that never happens.
But just because we can’t discover absolute certainty from our favorite technical metrics doesn’t mean we should discard them. A case in point is that we all know that weather forecasters are wrong sometimes, but there’s still plenty of reason to follow the latest meteorological predictions because they come true more often than not.
If you have some of your hard-earned money on the line in any of the securities markets, consider using between one and five technical indicators. There are hundreds of them, but they’re generally divided into five categories, based on what they predict or measure: volume, momentum, strength, reversion to a mean value, and trends. Here are some of the best ones for traders of all experience levels.
A moving average is useful for two reasons. It shows us the general direction of price, and it’s extremely easy to employ. You can plot based on different time periods, 200 and 50 days being the most popular. When the 50-day trend line crosses above the 200-day line, for instance, that usually reveals that prices are in an upward motion and will continue that way for a while.
Moving averages are especially crucial for premarket trading, the period from 4 a.m. until 9:30 a.m. when it’s possible to place orders before the regular session opens. Many institutional investors and individuals try to catch trends in advance of the opening bell by using moving average analysis.
RVol, which is short for relative volume, one of the newest tech metrics, can uncover some interesting patterns. The number is a ratio of today’s trading volume divided by an average day’s volume. Using relative volume to predict home run trades is the goal. When the RVol for a given security is high, it means that there’s much more interest than usual in those shares. High volume means spreads will tend to be small and liquidity high. It can also portend an upcoming movement, up or down, in price.
MACD, or moving average convergence divergence, is a fancy way of looking at momentum and fast changes in price. In essence, it is a very clever way of using averages of averages to determine turning points in value.
Stochastics are a mathematical way to find out when a given security is over-bought or over-sold. In other words, it measures the relative strength of the trend line. These are not used in isolation but with other indicators.
Bollinger bands appear on charts as ranges around plotted price lines. They’re calculated with a highly sophisticated math program that helps investors see when prices have gotten too high or too low and are ready to boomerang back to the mean, or average.