You have probably come across the term “technical analysis” by now and wondered what it entails. Well, technical analysis is financial analysis that uses patterns in market data to identify trends and make predictions. This is what most traders use to analyse the markets these days.

Now, within the world of technical analysis, traders use what are called technical indicators to find trading opportunities. There are literally thousands of different indicators around that you can use, but some are more important than others. In this lesson we will go through a few of the most widely used ones, namely the Exponential Moving Average, the Stochastic and the MACD.

Let’s start with the Exponential Moving Average (EMA), but to do that I will first have to explain a simple moving average.

A moving average is a line that is plotted on the chart itself to smooth out price moves. The trader selects the period of the moving average and it is calculated by averaging the price out over the selected period. So, if you choose a 10 period moving average, this will be the average of the last 10 periods (or candles).

You can see a 10 period Simple Moving Average (in red) on the image below:

The Exponential Moving Average is pretty much the same as a simple moving average except for the fact that it gives more weight to or importance to the most recent prices in its calculation. Since the EMA focuses more on the latest prices, it reacts faster to price changes than a simple moving average. This means it’s more sensitive to recent price movements, which can help traders spot trends earlier.

What is the EMA used for?

Spotting trends: Traders often use the EMA to help confirm if an instrument is trending up or down. If the price is above the EMA, it’s usually a sign that the stock is in an uptrend. If the price is below the EMA, it’s a sign of a downtrend.

Crossovers: Traders also look for when the price crosses above or below the EMA or when multiple EMAs cross each other. For example, if the price crosses above the EMA, it might be a signal to buy, while a price drop below the EMA could be a signal to sell.

Next up, we have the Stochastic Oscillator.

The Stochastic is an oscillator. This means that it’s value oscillates between the values of 0 and 100. Unlike the moving average, the stochastic is not plotted on the price chart itself, but is rather plotted in a separate window just below the chart.

It is calculated using some pretty complicated equations that you don’t really need to know about. All you need to know is that it produces ‘overbought’ and ‘oversold’ signals which, in layman’s terms, means that it shows you the momentum and the strength of the trend.

In the image above, you can see the stochastic line (green) moving up and down between 0 and 100. The blue line indicates the 20 level and the red line indicates the 80 level. When the stochastic is above the 80 or below the 20 it could indicate an imminent change in direction.

When the stochastic is higher than 80, it means that the trend is strong and if it has been above 80 and starts to turn downwards below 80, it could mean the momentum is changing and a reversal is imminent to the downside.

Similarly, if the stochastic has been below 20 and starts to turn upwards above 20, it could mean the momentum is changing and a reversal is imminent to the upside.

The final indicator we will be covering in this lesson is the MACD (Moving Average Convergence Divergence).

Now, similarly to the stochastic the MACD is also an oscillator that is plotted in a seperate window below the chart. This one show the relationship between two different moving averages and it has an additional EMA added which functions as a trigger for buy and sell signals. There is a histogram plotted on the chart which makes this easier to see.

The above image shows what it looks like. It may look complicated, but all you really need to know is that if the histogram (the green) is above zero it is a bullish signal meaning that the price is likely going up. If it is below zero it is a bearish signal meaning that the price is likely going down.

Hopefully this lesson has shed some light onto these three technical indicators. As mentioned before, there are thousands of different indicators that are used by traders but we chose to cover these ones as they are used in a trading strategy that we will be sharing with you in a few days from now. So keep an eye out for that.

Remember to contact us if you have any issues or queries.