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Understanding Technical Analysis: Key Indicators for Trading

Updated: 3 days ago


Author: Fabian Romano

Date of publication: 09/07/2023


Indicator

We often hear about indicators in any field related to analysis. Trading is no exception. But what is an indicator ? An indicator is an evaluation and decision-support tool, based on a measurable element. The latter allows us to consider the evolution of a process in relation to a reference point.


indicators in trading

In fact, there are many indicators in trading, and this article will focus on some of them:

  • Relative Strength Index (RSI)

  • Bollinger Bands

  • Moving Average


Relative Strength Index

The relative strength index (RSI) is a popular indicator that first appeared in 1978. It is used to assess the strengths and weakness of a financial asset, as well as to detect overbought and oversold conditions. The RSI is generally represented on a scale from 0 to 100. For example, an RSI above 70 is considered an overbought indication. This means that the asset is likely to be overvalued and could see a downward correction. On the contrary, an RSI below 30 is generally considered an oversold indication. In other words, the asset is likely to be undervalued and could experience an upward rebound.


RSI indicator is also used to confirm an asset’s trend. In particular, if the price trend is upward and the RSI continually reaches overbought levels with no reversal signal. This may indicate a strong uptrend. Similarly, if the price trend is downward and the RSI continually reaches oversold levels without a reversal signal. Therefore, this may indicate a strong downward trend.



relative strength index


Bollinger Bands

The analysis tool was developed by John Bollinger in the 1980s and adapted to the stock market. It is widely used to assess asset volatility and identify overbought and oversold zones.


Prices approaching the upper band are often seen as overbought signals. They indicate that the asset is potentially overvalued, and a downward correction could occur. Similarly, when prices approach the lower band, this can indicate an oversold zone. It suggests that the asset is potentially undervalued, so an upward rebound could occur. Therefore, it's important to note that prices touching or exceeding the bands are not necessarily reversal signals. So, further confirmation is often required.

A break of the bands can be a signal of continuation or reversal of the trend. When prices break out of the upper or lower bands, this may indicate a continuation of the current trend. For example, an upward break of the upper band may signal a continuation of the current uptrend. On the other hand, a downward break of the lower band may indicate a continuation of the downtrend.



bollingers bands

Moving Average

Moving Averages are tools commonly used in trading to track trends and identify buy and sell signals.


Moving averages can be used to visualise the general trend of a financial asset. An ascending moving average indicates an upward trend, while a descending moving average indicates a downward trend. So, traders can use different moving average periods (10 days, 50 days, 100 days, 200 days …) to identify different trend scales. If a short-period moving average crosses a long-period one, this can be considered as a buy signal.


Moving averages can be used as dynamic support or resistance lines. When the price of an asset bounces off an upward moving average, this may indicate a support level. Similarly, when the price retraces from a falling moving average, this may indicate a resistance level. Moving averages can be used to confirm other trading signals. When an indicator like the RSI gives an overbought or oversold signal, a moving average crossing in the same direction can reinforce this signal.



moving average


Conclusion

There are many indicators that can be used in different ways to measure the variable you need to enter/exit the market. So, you can adapt these indicators depending on the type of investment you want: short-term or long-term. You can do so by modifying the period of a Moving Average for example.


Remember that indicators are analytical tools; they do not guarantee that the market will behave exactly as they might predict.




Reference list

Relative Strength Index (RSI) Indicator Explained With Formula (investopedia.com)

Relative strength index - Wikipedia

Bollinger Bands® - Understanding How Bollinger Bands Work (corporatefinanceinstitute.com)

Bandas de Bollinger - Wikipedia, la enciclopedia libre

Les Moyennes Mobiles | XTB


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