There are tons of different indicators that are most often used by short-term investors. Here we will explain the major indicators that are most useful to all investors.
Trading indicators are plotted on or below price charts to help investors get a better understanding of how the price is behaving. They help to identify current trends and momentum in the past and in the future.
The most common trading indicator is the Moving Average (MA), which comes in different forms. A Moving Average is a “rolling” average that is calculated for a certain amount back in time. Examples are the 7-day, 30-day and 200-day Moving Average.
There are two different ways to calculate the Moving Average, which are called the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).
The Simple Moving Average calculates the average closing price over a defined number of days. All closing prices are weighted the same in this calculation. This can be in any form basically, but as we have said, 7 day, 30 days and 200 days are most used.
The Exponential Moving Average also calculates the average closing price over a defined number of days. The difference is that more recent closing prices are weighted more heavily in this calculation, which makes the EMA respond more quickly to price changes than the SMA.
Moving Averages are generally used by all investors, both long- and short-term investors. They should be understood by all investors for sure!
Moving Averages indicate trend changes in both the long-term and the short-term!
The second major trading indicator is the Relative Strength Index (RSI), which is a momentum oscillator that ranges from 0 to 100 and indicates if an asset is oversold or overbought.
A RSI below 30 means oversold, which means that an asset is sold heavily recently and is likely to move up in price soon. A RSI above 70 means overbought, which means that an asset is bought heavily recently and is likely to move down in price soon.
Unlike Moving Averages, the Relative Strength Index is more often used by short-term investors which we call day-traders. The RSI can also be used by long-term investors and can be useful to decide buying or selling moments.
The third major trading indicator is the Moving Average Convergence Divergence (MACD), which is a trend-following momentum indicator. The MACD shows the relationship between two different Moving Averages.
The MACD is calculated by subtracting the 26-day Exponential Moving Average from the 12-day Exponential Moving Average. This can sound pretty hard to understand at first, but luckily this trading indicator is most often used by short-term investors like daytraders.
There is also a MACD signal line, which is used to identify trends.
As a long-term investor you should only understand that if the MACD crosses above the signal line, the price is likely to move up. If the MACD crosses below the signal line, the price is likely to move down.
The MACD basically helps to identify potential trend reversals.
The fourth and last mentioned major trading indicator are Bollinger Bands, which measure price volatility. They consist of the middle band (Moving Average), the upped band and the lower band.
We will only explain the basics of the Bollinger Bands in short:
- If the price touches the upper band, there is strong upward movement;
- If the price touches the lower band, there is strong downward movement;
- If the Bollinger Bands widen, there is increased volatility;
- If the Bollinger Bands contract, there is decreased volatility;
Bollinger Bands are only used by short-term investors (or speculators) like daytraders, which are out after a quick profit.
We have now explained the four major trading indicators which we believe every investor should at least understand. As we the authors highly recommend our readers to be long-term investors, only a basic understanding of most of these indicators is needed!
Most important for you to understand are the different forms of Moving Averages!
If your goal is however to become a speculator or a daytrader, you should study all of these trading indicators thoroughly.