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4 technical indicators to follow
Stock charts graphically represent the rise and fall in prices. They may make your eyes glaze, but they are important. Not to mention, they can convey a lot of information and knowledge. And without these, you are on the way to lose your money.This is part of technical analysis, which looks at trends in price and trading volume to forecast the near future.
You don't need to be an expert to conduct technical analysis. It is fairly easy and publicly available too. However, remember, it is better to use technical analysis only if you are short-term trader.
Here are four key technical indicators you should know about:
You may often hear analysts and news reports mention the DMA or Day Moving Average. It is the most common technical indicator in use. The moving average is a simple line on the chart that connects the average closing prices over a certain period of time. This could be 5, 10, 20, 50 or even 200 days. The greater the period of time, the better the moving average. It helps you understand the underlying trend in the price movement. After all, prices don't move in a single direction. One day they are up, the next day they may be down. However, in the longer run, the stock price may have increased. The moving average helps understand this underlying trend by smoothening out the daily volatility.
Indication. If short term averages are cutting long term averages then it's a bullish signal as the trend is strengthening and we can take buying call on the stock with a specific stop loss either the level of long term moving avg or any retracement support and vice a versa. If we follow 1:4 ratio in using short term and long term avg then we have seen it gives better results. We follow 20 and 100 or 50 and 200.
The Bollinger Band takes the moving average line one step further. A Bollinger Band consists of three lines - the moving average, and an upper and lower limit line. These represent the stock's volatility or 'standard deviation' - the amount by which the stock price rises or falls from the average. Thus, the band gives a you an idea of the stock price's trading range.
Indication: If the stock's current price is below the Bollinger Band's lower line, then it indicates a scope for a future rise. You could then buy the stock. In the same way, you could sell the stock if its price climbs over the Band's upper limit. However, double bottom at lower boundary and double top upper boundary gives strong indication about the trend.
Stock prices keep going up and down. These are short-term cycles, irrespective of the bullish or bearish market trend. It is then easy to miss when the market trend changes. The momentum oscillator comes handy here. It is depicted within a range of 0 to 100. The indicator comes handy when the stock has hit a new high or low and you want to find out if it will fall or rise going forward. It, thus, helps understand when the market sentiment is changing.
Indication: Like other indicators, momentum oscillators are used in comparison with the stock's price. Suppose a stock has hit an extreme high, check the oscillator. If it has not reached the same level and is lower, then it would show that demand is falling slowly. This would indicate that the stock is likely to fall. In the same way, if the stock hits a new low, while the oscillator has not, then it could indicate a steady gain in demand. This would mean price will rise in the near future
Relative Strength Index:
The RSI compares the stock price's gains and losses. This is then computed in an index format, which helps narrow the RSI score between 0 and 100. The RSI rises when the stock gains, and falls when the price trends lower. Once the RSI rises or falls to a certain limit, you can change your trading strategy.
Indication: Usually, analysts prefer to sell a stock once its RSI touches a score of 70 and buy at the level of 30. However, not all stocks may follow this pattern. It is better to look at its volatility and RSI history to fix the upper and lower limits.
The markets correct whenever there is a stark difference in the price line and a technical indicator. On 5 November 2014, the Nifty touched a new high of 8,365 in the morning. However, this was much above the 200-day moving average (DMA). This indicated that the high levels could not be sustained. The benchmark finally gave up most of its gains to end at the same level as the 200-DMA of 8,339.9.