How to Use Technical Indicators
Indicators are tools used by stock chart readers to help them analyze the future potential of stocks and other securities. Most indicators are developed using formulas that calculate two basic data points--price and volume. Most chart software today offers a large number of indicators that can be plotted on a stock's price chart or below the price on the chart. This allows analysts to make comparisons between the stock price and various indicators.
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Instructions
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Measure money flowing into or out of a stock. Use money flow or accumulation/distribution indicators to determine whether trading volume represents overall buying or selling pressure. These types of indicators rise as buying increases.
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Determine whether a stock is overbought or oversold. Use an oscillating indicator, such as stochastics or the relative strength index, to determine whether the price is ready to reverse because of profit taking. When these indicators move to the upper pane of their plotted area, they indicate overbought price conditions.
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Measure the strength of the trend. Use indicators such as momentum or Average Directional Index, or ADX, to measure the strength of a stock's trend. ADX readings above 35, and momentum readings above 3, indicate a strong trend.
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Look for buy signals. All indicators can be used to find buy and sell signals. The Moving Average Convergence/Divergence, or MACD, histogram offers one of the easiest to read signals, making it one of the most popular indicators. A buy signal is produced when the MACD crosses above 0 on its histogram plot.
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Find the best price point at which to buy. Moving averages arguably offer the best way to measure a safe and reasonable place at which to buy a stock. For example, institutional investors tend to defend the 50-day average when a stock is in a strong trend. Waiting for the price to return to the 50-day average is a good place to buy.
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Tips & Warnings
One of the most useful ways to use stock indicators is to look for divergences between the stock price and the indicator. For example, if a stock price trades at a new high as the money-flow indicator is turning lower, it could indicate that many investors are selling into strength. Such a scenario offers a warning to investors, as it could mean the stock price will soon reverse.
Indicators are not foolproof. There is no clear evidence that trade signals indicators produce work most of the time. Indicators are not crystal balls that give you a glimpse into the future price of a stock. They are simply tools that help chart analysts view stock price and volume from different angles. Indicators behave differently under different market conditions. It takes years of experience and lots of trial and error to learn how to best assess an indicator's readings in various market conditions.
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