Beginner’s guide: Technical indicators in trading
Reading time: 7 minutes
New traders often fall into the misconception that, in order to be successful in trading, one must rely on instinct alone or be quite experienced at predicting when and where the market will move next. In reality, traders rely on data. One of the most widely used tools is technical analysis, which includes indicators that can help traders identify trends, momentum, volatility and potential market signals.
What are technical indicators?
Technical indicators are mathematical calculations based on an asset’s historical price, trading volume, or open interest. They are displayed using price charts and give traders an overview and insights into market activity.
The idea behind technical indicators is simple: price movements leave patterns that traders can analyse to spot potential trading signals. Technical indicators can also be used when trading CFDs on forex, stocks, indices, commodities, cryptocurrencies, and other financial instruments. Simply put, a trader who uses technical indicators means he or she does not make trading decisions based on speculation or emotion.
Especially for beginners, there’s a wealth of benefits to being adept at interpreting and using technical indicators to inform one’s trades:
- Identify market trend
- Measure buy and sell momentum
- Spot possible reversals
- Find potential entry and exit points
- Confirm trade ideas prior placing an order
- Improve risk management
Common technical indicators
Moving Averages
One of the simplest and widely used technical indicators, a moving average smooths out short-term price movements by computing the average price of a stock over a chosen period. Knowing the average makes it easier to determine where the market could be headed.
Moving averages can reveal different insights based on the time period. For example, a 20-period moving average reacts to quick price changes; a 50-period moving average is commonly used to assess medium-term trends, and a 200-period is used to identify long-term market direction.
When the price of an asset trades above a moving average, it may indicate an upward momentum or a bullish trend. On the other hand, when the price falls below it, the trend may be weakening.
Relative Strength Index (RSI)
RSI is a momentum indicator that measures the magnitude of recent price movements and is often used alongside other forms of analysis, such as trend analysis, rather than in isolation.
The RSI ranges from 0 to 100. Traditionally, a reading of 70 or above is considered overbought, while a reading below 30 is considered oversold. However, these levels should not be viewed as automatic buy or sell signals, as RSI can remain in overbought or oversold territory for extended periods, particularly during strong trends.
It’s worth noting that an overbought market does not necessarily mean prices will fall immediately. Similarly, an oversold market does not guarantee a rebound. Instead, these readings suggest that momentum may be reaching potentially extreme levels, which traders can consider alongside other market signals.
Moving Average Convergence Divergence (MACD)
MACD is a popular technical analysis tool used to assess momentum and trend direction. It is generally more useful in trending markets, while sideways or range-bound conditions can produce more false signals.
The MACD is visualised through three primary elements:
- MACD Line: Calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA.
- Signal Line: A 9-period EMA of the MACD line, which is commonly used to identify potential trading signals when it crosses the MACD line.
- Histogram: A visual bar chart showing the difference between the MACD line and the Signal Line.
Traders may use these components to assess changes in momentum and potential shifts in trend direction. However, MACD signals are not guaranteed to predict future price movements and are generally considered alongside other forms of analysis.
Bollinger Bands
Developed by John Bollinger, Bollinger Bands are commonly used to assess market volatility. The indicator consists of three lines: a middle line representing a simple moving average (SMA), and upper and lower bands typically set at two standard deviations above and below the SMA.
Bollinger Bands can also help traders identify potentially overextended price conditions. However, a move towards or beyond the upper band does not necessarily mean an asset is overbought, nor does a move towards the lower band automatically mean it is oversold.
One strategy involves looking for double bottoms, where price tests the lower band twice and the second decline shows signs of weakening momentum, potentially signalling a reversal. A double top is the opposite pattern and can indicate a potential bearish reversal. Traders may also use a move through the middle band as additional confirmation, alongside other forms of analysis.
Stochastic Oscillator
Like the Relative Strength Index, the Stochastic Oscillator ranges from 0 to 100, with readings above 80 generally suggesting overbought conditions and below 20 suggesting oversold conditions. It compares an asset’s latest closing price with its recent high-low range. Traders can then look for crossovers between its two lines as potential trading signals. The indicator is particularly useful in range-bound markets, although overbought and oversold readings do not necessarily signal an immediate reversal.
Fibonacci Retracement
Fibonacci Retracement is a popular charting tool used to identify potential areas of support and resistance following a significant price movement. Traders commonly monitor levels such as 23.6%, 38.2%, 50%, 61.8% and 78.6% to assess whether prices may pause, reverse or continue trending. Rather than treating these as exact turning points, traders can view Fibonacci levels as areas where market reactions may occur.
Average True Range (ATR)
The Average True Range (ATR) measures volatility rather than market direction. A higher ATR indicates greater price volatility, while a lower ATR suggests calmer market conditions. Traders may also use ATR to help determine stop-loss distances, as it reflects an asset’s average price range over a specified number of periods.
Trade with confidence with FP Markets
For beginners, it is better to learn how to use a small number of popular indicators than to constantly search for more complex strategies. As your experience grows, you can combine different indicators to build a trading system that fits your goals, preferred markets, and risk appetite.
When you open a live trading account with FP Markets, you will have access to advanced charting tools, multiple technical indicators, and powerful trading platforms like MetaTrader 4, MetaTrader 5, cTrader, etc. Whether you are putting into action your first strategy or refining your existing trading skills, FP Markets provides the resources to help you analyse the markets with greater confidence.
Frequently asked questions (FAQs)
There is no single best indicator. Many beginners start with Moving Averages, RSI, and MACD because they are relatively easy to understand and widely used.
It is generally better to use two or three complementary indicators rather than relying on just one. Combining indicators can help confirm trading signals and reduce false entries.
No. Technical indicators are analysis tools that help identify potential trading opportunities, but they cannot predict market movements with complete accuracy. Proper risk management is still essential.
