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What Are Technical Indicators in the Stock Market and How Do They Work?
If you’ve ever looked at a stock chart on a trading platform and seen multiple lines moving in different directions, you’ve likely encountered technical indicators. These tools are crucial in helping traders understand price movement, predict market direction, and make informed decisions.
But what are the top 5 technical indicators, and what are the 4 types of indicators used in technical analysis? This guide will walk you through key concepts and essential indicators every trader should know, especially if you're trading on platforms like PSX or PMEX.
A technical indicator is a mathematical calculation or visual overlay derived from historical price, volume, or open interest data. Traders use indicators to:
These indicators act as decision-support systems. They don’t guarantee success but help increase the probability of accurate analysis.
Technical indicators generally fall into four categories based on their function:
Each of these types gives a different insight into market behavior. Traders often use a combination to reduce risk and confirm signals.
Let’s explore five of the most widely used technical indicators and how they assist in trading decisions:
RSI is a leading momentum indicator developed by J. Welles Wilder. It helps identify whether a stock is overbought or oversold, indicating potential trend reversals.
Formula:
RSI = 100 - (100 / (1 + RS))
Where: RS = Average Gain / Average Loss (typically over 14 periods)
Example: Let’s say PPL's 14-day average gain is 2.07 and average loss is 0.714:
RS = 2.07 / 0.714 = 2.899
RSI = 100 - (100 / (1 + 2.899)) = 74.35
A value near 74 suggests the stock may be overbought. RSI is especially useful during sideways markets.
Often referred to as the “grand old daddy” of indicators, MACD is a trend-following momentum indicator. It shows the relationship between two exponential moving averages (EMAs):
Uses:
MACD is particularly helpful for identifying trend strength and changes.
Created by John Bollinger, Bollinger Bands (BB) are volatility indicators that adapt to market conditions. They consist of three lines:
Trading Logic:
BBs work best in range-bound markets and can provide early signals in periods of low volatility.
Moving Averages (MA) smooth out price data to reveal the underlying trend. They are of two main types:
Traders use MAs to:
Moving averages form the foundation of many other indicators like MACD and Bollinger Bands.
While not covered in the original draft, the Stochastic Oscillator is another momentum indicator worth knowing. It compares a stock's closing price to its price range over a specific time.
Formula:
%K = ((Current Close - Lowest Low) / (Highest High - Lowest Low)) × 100
Commonly used with RSI for confirmation.
While indicators like RSI, MACD, and Bollinger Bands are powerful, they should not be used in isolation. Always combine them with:
No indicator can predict markets with 100% accuracy. They are best used as decision-support tools, not decision-makers.
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