Ever since the birth of technical analysis in the 18th century in Japan, it hasn’t stopped evolving. Today, there are hundreds of different technical indicators that traders use to predict the market’s behaviour better.
For simplicity, trading indicators are often divided into different categories based on their function. These include oscillators, volatility, volume, support/resistance, trend-following, leading, and more.
1. Volume Weighted Average Price – VWAP
The VWAP is a trading indicator that uses volume and pricing information to calculate the average price the instrument has traded at during the trading session. That way, instead of relying only on the closing price, the trader can get a fair representation of the price of the instrument based on the volume of transactions.
On a chart, the Volume Weighted Average Price indicator is plotted as a moving average. The easiest way to use it is similar to MAs. If the price is above the VWAP, the market is dominated by a bullish sentiment and vice-versa.
The VWAP is essential because it gives insights into the health of the particular instrument. For example, if the stock has hit a new high with high trading volume or hit a new high with a minimum trading volume. Based on this, the trader can understand whether the price is stable or if it is more likely to change in the short-term.
Retail traders use the indicator also to evaluate whether a particular moment is suitable for buying and selling and to protect their portfolios from whipsaw effects in the price of the traded instruments.
Large-scale investors use the VWAP to time moments to get in and out of a trade with as little effect on the market as possible.
When using VWAP trading on an intraday basis, the consensus is that if the price hovers below the indicator, the instrument is “cheap,” while when above it, it is “of value.” Bear in mind that the VWAP isn’t indicative of long-term performance and may not be suitable for spotting stable trends.
2. Fibonacci Retracement
Fibonacci Retracement is usually in the top 3 of each trader’s favorite technical tools. The indicator consists of different levels (horizontal lines) plotting the most likely zones where support and resistance can form. The zones are identified based on the Fibonacci numbers.
On a chart, each Fibonacci Retracement line is plotted depending on the percentage of a prior price move. The official and most widely used levels are 23.6%, 38.2%, 61.8%, and 78.6%.
Traders can plot the Fibonacci Retracement levels between any high and low price of the traded instrument. The percentage levels are automatically drawn and indicate the most likely support and resistance lines.
The indicator is handy for placing entry orders, set targets, and plot stop-loss levels. It signals potential reversals, price breaks, overbought, and oversold markets. Unlike Moving Averages, for example, Fibonacci Retracement levels aren’t dynamic. They are fixed and don’t follow the price changes.
3. Moving Average Convergence Divergence – MACD
Moving Average Convergence Divergence (MACD) is, per definition, a trend-following momentum oscillator that helps traders identify the formation of a new strong trend. It was developed in the late 1970s and is considered one of the easiest and most effective day trading indicators.
The MACD indicator is visualized as two moving averages (a shorter and a longer one), oscillating around the zero line. Occasionally, they might cross it or diverge and converge. These movements generate trading signals like crossovers, convergences (the lines move towards each other), or divergences (the lines move away from each other). By keeping track of the MACD line, the trader can discover when a new trend is about to form.
The shorter MACD line is a 12-day EMA and moves quicker. It is responsible for the majority of the indicator’s movements. The longer MACD line is a 26-day EMA, and it is slower to react to price changes.
Traders use the MACD to identify overbought or oversold markets better. Alternatively – when an asset’s price is trending above or below its intrinsic/real value.
4. On Balance Volume – OBV
OBV is from the volume indicators group and predicts upcoming changes in the instrument’s price. It was first introduced in 1963.
As its name suggests, the momentum indicator uses the volume flow. It is based on the idea that the traded instrument’s price should be reflected in its volume. According to the theory behind the indicator, an increase in the traded volume will always lead to upward or downward price action, depending on what types of orders prevail.
OBV helps traders predict the market sentiment by signaling whether a bearish or a bullish trend is more likely to follow (i.e., measures the buying and selling pressure).
The indicator can be positive or negative. However, traders don’t care about the actual value. Instead, they look at the direction of the line to spot divergences, trend confirmations or reversals, breakouts, exhaustion moves, and more.
The OBV is also used to signal when institutional and retail investors are present on the market and distinguish the volume generated by either group.
5. Bollinger Bands
Bollinger Bands are among the most popular volatility indicators. It was introduced in the 1980s by John Bollinger. Using a Moving Average, sandwiched between two trading bands (a positive and a negative standard deviation apart), the indicator signals the price volatility levels and their change over time.
The day trading indicator is straightforward and extremely handy as it combines all the needed pricing information within a simple and easy-to-comprehend shape on the price chart.
Traders use Bollinger Bands to identify overbought and oversold market conditions. If the price breaks the upper line, the signal is bearish. The price is expected to drop (i.e., a good moment to sell). On the other hand, if it breaks the lower line, the price is expected to increase. Understandably, this is a good moment to buy.
More advanced traders learn to identify trading opportunities based on the price continuously touching the indicator’s lower or upper bands.
Bear in mind that Bollinger Bands is prone to generating false trading signals. To avoid being deceived, make sure to wait for firm confirmation of the signal or combine it with additional tools. For example, if you are using it to spot overbought and oversold signals, the best way to do is to wait for an entire candle, confirming the bullish/bearish signal to close. If you open a position before that, you risk ending up on the opposite side of the trend.
6. Average Directional Movement Index – ADX
The Average Directional Movement Index is an indicator that measures the trend’s strength and is calculated as an average of expanding price range values. The strength of the price movement is measured in a positive or a negative direction.
The ADX consists of three separate lines. When plotting it on the chart, you will see that the ADX is accompanied by two technical indicators – the positive directional indicator (+DI) and the negative directional indicator (-DI).
The ADX itself indicates the strength of the trend. If the ADX shows values above 25, the movement is considered strong. On the other hand, values below 20 indicate that the trend is weak. The complementing momentum indicators (+DI and -DI), on the other hand, represent the trend direction.
Some advanced traders base their trading decisions only on the buy or sell signals the +DI and -DI generate. For example, a case where the -DI crosses above the +DI and the ADX sits above the 20 or the 25 marks is usually considered a sell signal.
Collectively, the indicator helps day trading pros assess whether they should go long or short or avoid trading at all.
7. Relative Strength Index – RSI
The Relative Strength Index (RSI) is among the most popular and widely used technical analysis trading tools. Traders use the RSI to spot overbought and oversold markets.
The way the oscillator works is simple. The RSI measures the magnitude of the asset’s price fluctuation and tells whether the current price trends are fair or not. It is displayed as a line on a graph, floating between two extremes, with a value between 0 and 100.
When using the RSI indicator, day traders look for convergences and divergences. If the indicator’s highs and lows move in the same direction with the price trend, then a convergence occurs. In that case, the trader knows the trend is strong and likely to continue. And vice-versa.
Usually, the RSI fluctuates between the 30% and 70% marks. Based on that, it generates bullish and bearish buy and sell signals.
Although the interpretation isn’t so straightforward, the general idea is that when the RSI is around 70%, the market is overbought, while when it is around 30%, it is oversold. A trend is confirmed when the RSI moves towards or away from the 50% mark. The RSI works differently compared to the relative volume indicator.
8. Simple Moving Average – SMA
As its name suggests, the SMA calculates the average of the closing prices of a particular instrument. The indicator is updated constantly, and the average price is taken over a specific time frame. The goal of the SMA is to smooth out pricing data by extracting the noise.
The Simple Moving Average is the go-to indicator every beginner should learn in the first place. When applied on a chart, it is straightforward and easy-to-use as all you have to do to get an idea about the price trend is to look at the direction of the line. If it is trending in an upwards direction, so is the price of the instrument. And vice-versa.
The most important thing to learn about the SMA is that it is a lagging (trend-following) indicator based on past price movement data. For example, if you see the term 50-day SMA or 200-day SMA, you should know that they are based on the price action for the last 50 and 200 days, respectively.
The SMA is highly customizable, and you can construct it over short and long trading periods. Bear in mind that the shorter the time frame is, the more sensitive the SMA becomes to price changes.
Traders use SMA also as support and resistance levels when applied on longer time frames.
9. Exponential Moving Average – EMA
Think of EMA as an enhanced simple moving average, which is why it is among the most popular trend indicators. The main difference between EMAs and SMAs is that the exponential moving average puts more weight on recent prices. Both moving averages are used for the same purpose and are interpreted in the same way.
The EMA is considered a more timely indicator and is preferred by traders looking for a clearer picture of the current price action developments. Short-term traders usually rely on the 12-day and 26-day EMAs, while the long-term ones prefer the 50-day and 200-day indicators.
Traders use exponential moving averages to identify oversold and overbought market conditions, reversals or continuations of the direction of the trend, and support and resistance areas. Similar to the other moving averages, here, you should also be looking for line crosses to identify buy or sell signals. Having the short-term EMA cross above the long-term one from below is interpreted as a buy signal and vice-versa.
If you want an indicator that is more sensitive to the recent price changes in the traded instrument, make sure to go with the exponential moving average.
10. Candlestick Pattern Recognition Indicators
Classical technical trading indicators help determine price trends, identify overbought and oversold market conditions and identify support and resistance zones. Technical indicators become even more powerful when they are combined with candlestick patterns.
A hammer, for example, is a bullish reversal pattern. A reversal becomes more likely when it appears at a support zone, for instance, at VWAP or in an oversold market.
Candlestick pattern recognition systems can help you identify candlestick patterns of your choice automatically and highlight the identified patterns on price charts.
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Best Trading Indicator Summary
The most important thing to bear in mind when it comes to technical trading indicators is that even the best ones aren’t 100% efficient when used on their own. Make sure to combine several tools to validate the signals and improve your trading plan.
Fortunately, traders nowadays can take advantage of hundreds of different indicators. From decades-old and widely-spread ones to custom setups – there are technical trading tools for every style, level of understanding, and investment objectives.
Some other frequently used day trading indicators are the True Strength Index and Supertrend Indicator.
Also, some trading indicators combine price, time and volume into one indicator. One of the most popular ones is the market profile indicator. The market profile is primarily used for day trading future contracts.
Bear in mind that the best way to identify the best trading indicators for your trading strategy and market is to test them out with paper money. If they show good efficiency, feel free to go live. On the other hand, if they fail to deliver on the training ground, they will surely let you down when trading with real money.
What are the best indicators for day trading?
The best indicators for day trading are the Volume Weighted Average Price (VWAP) and Fibonacci retracements for support and resistance evaluation and the 9EMA for short-term trend determination.
Which indicator do most traders use?
Most traders still use classic moving averages, exponential moving averages, and trading volume as indicators for their charts. However, VWAP and Anchored VWAP become more popular recently.