Every stock market investor aspires to become a successful one by making consistently substantial gains. However, to gain success in stock market investing, one needs to develop two very important and unique skills, understanding of fundamental analysis and reading technical charts. Both these are very different from each other, but are equally important for understanding and predicting stock performance.
Read More – Technical Analysis – A Complete Guide
Fundamental analysis involves studying a company’s financials. In this, one goes through all the aspects that may potentially impact a company’s value. Technical indicators make use of technical charts to identify profitable entry and exit prices of stocks by looking at the long-term patterns in stocks.
Here, we will discuss the concept of technical indicators and also share 5 of the most commonly used technical indicators that every investor should know about.
What is a technical indicator?
A technical indicator in stock investment analysis involves mathematical calculations that use historical prices, trading volumes, interest information, etc to forecast stock price and overall financial market direction. Technical indicators generally come in the form of chart patterns that can help investors or traders in predicting market trends. Indicators are generally plotted on price charts to indicate price directions. In simple terms, these tell the reader whether the stocks are in overbought or oversold condition.
Top 5 commonly used technical indicators
Over the years, there have been many technical indicators that are developed with new variants continuing to enter the trading world. Of these, 5 of the most commonly used technical indicators are:
Volume indicates the quantity of shares bought and sold over a given period. Investors and trades generally compare a chosen stock’s volume to its average price for a selected period. As volume gives an investor/trader a good insight into the general market perception about the stock for a given period. This way, they can understand and predict the stock movement and accordingly take trading or investment decisions.
As an example, suppose an investor sells 100 shares of a company at Rs. 10,000. Thus, the buyer and the seller jointly create a volume of 100 for the given stock. Volume is an important indicator about trade confirmation, however, it is never used as a stand-alone indicator but jointly with other indicators and technical price patterns.
MACD or Moving Average Convergence Divergence is used by investors/traders to check for trade signals. This technical indicator comprises 2 lines, that is MACD and the signal line. Both these lines move at different paces since the signal line generally moves slower as compared to the MACD line. If the MACD line crosses the signal line from above, it is an indicator of an uptrend in stock prices. If MACD crosses the signal line from below, the stock price may likely fall further. This information helps investors in deciding whether to buy or sell a stock.
- MACD above zero – indicates a bullish view and the stock price will likely move upward
- MACD below zero – indicates a bearish period and the stock price may likely go down
- Support and Resistance
A stock’s price may move around certain levels depending on the stock’s demand and supply. In general, these could either move up or down, indicating either support or resistance.
- Support: Support is triggered by demand of the stock and it keeps the price from dropping down beyond a level. This is the price level, where maximum demand for the stock can be expected. A support level also indicates high chance of price reversal towards an upside. Actual stock prices are mostly more than the support price levels.
- Resistance: It keeps the stock prices from rising. At a resistance level, maximum supply of the stock can be expected, indicating high chances of price reversal that will result in stock prices moving downwards. Actual stock prices are generally lower than the resistance price levels.
- Bollinger Bands
This indicator is used to gauge the price range of stocks and know how these will move within the given range. The price range width may expand or contract depending on the market volatility. A narrow bollinger band means that the market volatility is low, whereas a wider band means higher market volatility. Investors/traders use bollinger bands to also identify if a stock price is moving outside its band. In case it moves outside the upward band, the stock is said to be overbought. A stock may be oversold if its price is moving below the downward band.
RSI or Relative Strength Index is a technical indicator that can range from 0 to 100. It is used by investors/traders to understand the current market trend and the strength of a momentum. It tells market participants whether a share is currently overbought or oversold.
If a stock’s RSI is above 70, it is said to be overbought and the price is likely to fall.
RSI below 30 means that the stock is oversold and its price may move upwards in the upcoming trading cycle.
RSI divergence is also used as an indicator. If the RSI indicator goes against the ongoing market pattern, it means that the market trend is likely losing its strength and may therefore experience a reversal.
Since the stock market can be very dynamic, with many factors influencing its performance, technical indicators help traders and investors in gauging market trends. These offer useful information that can be used to maximize returns and minimize risks. A new investor or a trader who is just starting off with stock market trading can make use of the above-mentioned 5 indicators that are commonly used in the markets.
Fundamental analysis involves studying a company’s future profitability by looking at factors like financial standing and business environment. It considers both qualitative and quantitative factors such that the investor can decide about investing in the company. It gauges the general efficiency of a company’s operations, profit-making ability and future growth prospects.
Fundamental analysis is best suited for long-term investors since it is more theoretical in determining the long-term value of a stock. Technical analysis is practical for short-term or medium-term investors as it studies the price performance of stocks and trends.
Stock markets are generally risky because of constantly changing prices of securities. The price volatility is driven by multiple factors like economic conditions, market sentiments, company performances, news, etc.
Technical analysis is mostly used by short-term and day traders who aim to make profits through quick trading and short-term price movements. Therefore, it may not be suitable for new investors since it also requires sufficient understanding of the markets.
Technical analysis may be difficult to follow for new stock market investors since it requires a strong understanding of the market and price movement patterns. Once an investor gains sufficient knowledge of the markets, it is easier to understand and follow technical analysis.