Technical indicators are heuristic or pattern-based signals produced by the price, volume, and/or open interest of a security or contract used by traders who follow technical analysis.
By analyzing historical data, technical analysts use indicators to predict future price movements. Examples of common technical indicators include the Relative Strength Index (RSI), Money Flow Index (MFI), stochastics, moving average convergence divergence (MACD), and Bollinger Bands.
Key Takeaways
- Technical indicators are heuristic or mathematical calculations based on the price, volume, or open interest of a security or contract used by traders who follow technical analysis.
- Technical analysts or chartists look for technical indicators in historical asset price data to judge entry and exit points for trades.
- There are several technical indicators that fall broadly into two main categories: overlays and oscillators.
How Technical Indicators Work
Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Unlike fundamental analysts, who attempt to evaluate a security’s intrinsic value based on financial or economic data, technical analysts focus on patterns of price movements, trading signals, and various other analytical charting tools to evaluate a security’s strength or weakness.
Technical analysis can be used on any security with historical trading data. This includes stocks, futures, commodities, fixed-income securities, currencies, and other assets. While our examples often focus on stocks, these concepts apply universally. Notably, technical analysis is especially prevalent in commodities and forex markets, where traders focus on short-term price movements.
Technical indicators, also known as “technicals,” are centered on historical trading data, such as price, volume, and open interest, rather than the fundamentals of a business, such as earnings, revenue, or profit margins. Technical indicators are commonly used by active traders to analyze short-term price movements, but long-term investors may also leverage these indicators to time their entry and exit points effectively.
Types of Indicators
There are two basic types of technical indicators:
- Overlays: These indicators use the same scale as prices and are plotted directly on the price chart. Examples include moving averages and Bollinger Bands.
- Oscillators: These indicators oscillate between a local minimum and maximum and are plotted above or below a price chart. Examples include the stochastic oscillator, MACD, or RSI.
Traders often use a variety of technical indicators when analyzing a security. With a multitude of options available, selecting the most effective indicators for one’s strategy is crucial. Traders often combine technical indicators with chart patterns and other forms of technical analysis to develop comprehensive trading strategies. Given their quantitative nature, technical indicators can also be incorporated into automated trading systems.
Example of Technical Indicators
The following chart illustrates some commonly used technical indicators, including moving averages, the RSI, and the MACD.
In this example, the 50- and 200-day moving averages are plotted over the prices, depicting current price relative to historical averages. The 50-day moving average being higher than the 200-day moving average suggests a positive overall trend. The RSI above the chart, at a neutral 49.07, indicates the trend’s strength. The MACD below the chart illustrates the convergence or divergence between the moving averages, showing a slightly bearish signal in this case.
Related Terms: moving average, RSI, MACD, Bollinger Bands, trading volume, open interest.
