Charts are messy. A raw price chart is just a jagged line of human emotion: greed, fear, and panic plotted against time. To make sense of it, traders use indicators. These are mathematical formulas applied to price and volume data, designed to smooth out the noise and reveal the “truth.”
Or at least, that is the sales pitch.
In reality, most indicators are lagging. They tell you what just happened, not what is about to happen. A chart with twenty indicators on it is not a sign of a sophisticated trader; it is a sign of a confused one. The goal is not to find a magic crystal ball. It is to find a few reliable tools that help you frame the market’s behavior.
Here are the top 7 indicators that are commonly used by traders and they deserve a spot on your screen, stripped of the mystic mumbo-jumbo.
1. Moving Averages (The Trend Filter)
The Moving Average (MA) is the grandfather of technical analysis. It is blunt, simple, and essential. It calculates the average price over a specific number of periods, creating a smooth line that filters out the daily chop.
- The 200-Day MA: This is the line in the sand for the long-term trend. Institutions watch it. If the price is above the 200-day, the market is generally viewed as being in an uptrend. If it is below, the market is often considered to be under pressure. It acts as a widely observed psychological support or resistance level.
- The 50-Day MA: This is the intermediate trend. When the 50-day crosses above the 200-day (the “Golden Cross”), it is commonly interpreted as a bullish signal. When it crosses below (the “Death Cross”), traders often adopt a more cautious stance..
Moving averages do not predict tops or bottoms. They tell you which way the wind is blowing so you don’t spit into it.
2. Relative Strength Index (The Exhaustion Gauge)
The RSI is a technical momentum oscillator. It measures the speed and change of price movements. It answers a simple question: has the market gone too far, too fast based on recent price action?
The RSI scale runs from 0 to 100.
- Above 70: The market is commonly described as “overbought.” Buyers are exhausted, and a pullback may occur.
- Below 30: The market is commonly described as “oversold.” Sellers are exhausted, and a bounce may occur.
The trick with RSI is that in a strong trend, it can stay overbought or oversold for a long time. It is not a standalone sell signal. It is a warning light. It tells you that the rubber band is stretched, but it does not indicate timing or direction of future price movements.
3. Volume (The Lie Detector)
Volume is the only indicator that is not derived from price. It represents the number of shares or contracts traded. It is the fuel of the market.
Price tells you what happened. Volume tells you how many people cared.
- A breakout on low volume: This may be misleading. It suggests a lack of conviction. Market participants may not be fully supporting the move.
- A breakout on high volume: This is generally viewed as more reliable. Larger market participants may be involved. The move has weight behind it.
Volume confirms trends. If the price is rising but volume is falling, the trend may be running out of gas.
4. MACD (The Trend-Momentum Hybrid)
The Moving Average Convergence Divergence (MACD) is the Swiss Army knife of indicators. It combines trend-following with momentum. It tracks the relationship between two moving averages of a security’s price.
Traders look for two things:
- Crossovers: When the MACD line crosses above the signal line, it commonly interpreted as a bullish entry signal. When it crosses below, it is considered as a bearish indication.
- Divergence: This is the sophisticated play. If the price is making a new high but the MACD is making a lower high, it indicates that the momentum underneath the move is weakening. A reversal may follow.
5. Bollinger Bands (The Volatility Trap)
Bollinger Bands are volatility bands placed above and below a moving average. They expand when the market is wild and contract when the market is quiet.
They are useful for identifying two states:
- The Squeeze: When the bands get very narrow, it means volatility has died. This is often described as the calm before the storm. A significant move is often preparing to launch.
- The Mean Reversion: Prices tend to stay within the bands. If the price touches the upper band, it is usually considered expensive. If it touches the lower band, it is considered cheap. Traders use this to observe extremes.
6. VWAP (The Institutional Benchmark)
The Volume Weighted Average Price (VWAP) is the only indicator on this list that resets every day. It calculates the average price a stock has traded at throughout the day, based on both volume and price.
This is commonly used as the benchmark for institutional traders. If a mutual fund wants to buy a million shares, their bonus depends on buying them at a price better than the VWAP.
- Above VWAP: The bulls are often viewed as in control.
- Below VWAP: The bears are often viewed as in control.
Day traders use VWAP as a dynamic support and resistance line. It can help illustrate who is currently winning the battle for the day.
7. ATR (The Risk Manager)
The Average True Range (ATR) does not tell you direction. It tells you volatility. It measures the average range of price movement over a set period.
Why do you need it? For risk management purposes, including your stop-loss.
If you place a tight stop on a volatile stock, you may get shaken out by random noise. If you place a wide stop on a quiet stock, you may be taking unnecessary risk.
Professional traders often use ATR to inform their stop placement. A stop-loss might be placed “2 ATRs” below the entry price. This help ensures that the stop is based on the observed behavior of the market, not an arbitrary dollar amount.
The Bottom Line
Indicators are tools, not crutches. They help you frame the market, but they cannot trade for you. A hammer is a great tool for building a house, but if you don’t have a blueprint, you’re just smashing wood. Use these indicators to support your thesis, assist with risk management, and help filter out the noise. But never forget that the only thing that ultimately reflects market outcomes is price.
Final Reminder: Risk Never Sleeps
Heads up: Trading is risky. This is only educational information, not an investment advice.