Technical analysis is an ancient practice in which traders around the globe try to anticipate the market by doing their own analysis. Frequently, analyses include and are carried out with both technical indicators as well as price action.

What are technical indicators and how do they influence the price?

Technical indicators are mathematical operations with the data that the price of an asset gives to us. These calculations are visualised in the chart, so the trader can easily get insights of the behaviour of the price.

The technical indicators can be classified in groups, according to which aspect of the price they analyze. These are volume, momentum, trend and volatility. Traders can combine indicators from different groups or focus on a specific one.

But, what makes these indicator/s accurate? Technical analysis is heavily influenced by the so-called “self-fulfilling prophecy”. It suggests that the individual’s predictions or expectations become true simply because the majority of people believe they will. Therefore, the trading behaviors of these individuals align to fulfill those beliefs.

So, if a lot of traders believe that the price can increase after, for example, a bullish SMA (Simple Moving Average) crossover, the price might effectively surge, basically because many traders believed in it and placed their buy orders after the cross.

Due to this, it is essential to know which indicators to choose. Selecting the right indicators will turns the odds in your favor.

The 5 most used technical indicators

MACD

The MACD (Moving Average Convergence/Divergence) is a combination between a trend and momentum indicator, and is one of, if not the most popular and widely used indicator in trading.

It shows the relationship between a 26-candles EMA (Exponential Moving Average) and a 12-candles EMA. From there, the MACD line is calculated by subtracting the first one from the second one. Finally, there is a so-called signal line, which is a 9-candles EMA of the MACD line.

This technical indicator is frequently used to foresee trend reversals and trades along upward and downward trends. There are two ways in which the MACD can be used:

    • MACD crossovers

These crossovers take place when the signal and MACD line cross each other, generating buy and sell points by doing so.

A bullish signal takes place when the MACD line crosses the signal line in an upward move. Suggesting that the price is reverting upwards or making a retracement. A bearish signal occurs when the MACD line crosses the signal line in a down-move, insinuating exactly the opposite.

top 5 most used indicators macd crossover

    • MACD divergences

This helps to pinpoint the end of a bullish/bearish rally. It will be considered a buy signal when the price and the MACD line diverges during a downward trend. When the price keeps on trending down and the MACD line starts going up, as shown in the image below, it suggests that the current downward trend might be over. After this it will potentially lead to a trend reversal, offering a trading opportunity.

top 5 most used indicators macd divergence


SMA

The SMA (Simple Moving Average) is a trend indicator that smooths price movements to filter out the noise of an asset, and pinpoint the direction of the trend more clearly. It is the most basic version of the moving averages and is obtained by calculating the average price during a specific number of candles or periods.

Traders frequently use this indicator to open and close trades through moving averages crossovers, and to find supports and resistances in different time frames.

During a bearish trend, when the fast SMA crosses the slow one upward, the trend is likely to have a reversal or correction, and signals a buy. However, in a bullish trend and the fast SMA crosses the slow one downward, we will get a sell point.

top 5 most used indicators sma crossover


Bollinger Bands

Bollinger bands is one of the most used indicators to spot volatility. It is made up of three lines: the center one is a simple moving average and the other two a lower and upper standard deviation. Since the bands measure the volatility of a specific market, whenever the volatility peaks the bands widen, and during less volatile periods, they contract.

The Bollinger bands provide buys and sell points through crossovers of the price with the upper or lower band. When the price breaks the lower band, it is interpreted as a buy signal. On the other hand, if the price breaks the upper one, it will be a sell.

top 5 most used indicators bollingerbands


RSI

The RSI (Relative Strength Index) measures the momentum of the price. When it is increasing, the bulls are taking over the market. If it decreases, the bears are in charge.

It can be used in different trading styles and for various purposes. Usually, traders all around the globe use the indicator by defining overbought and oversold zones.

Overbought zones are areas where the price has risen a lot in a small interval of time. Therefore, it considers that the asset is likely to have a bearish trend reversal or correction and the RSI will signal a sell. On the other hand, oversold zones are the opposite and are interpreted as buy signals.

top 5 most used indicators rsi

Volume

Volume itself is not like other indicators. In its overall form, it doesn’t actually make any form of calculation, nor does it gives buy/sell signals. What volume does measure is how much of a specific currency, asset or cryptocurrency is traded within a determined period of time. It’s a simple but powerful tool that every trader should take into account.

So...if volume doesn't give a buy or sell signal, why should we use it?

Well, the volume is the fuel for price movements and, therefore, reveals a lot of important information about the behavior of the price. If it is well decoded, it can provide us with some great hints of future price directions.

Indicators that take into account volume in their calculations like the OBV, Money Flow Index and Chaikin A/D Oscillator can help traders to find buy and sell points.


Conclusion

Technical indicators are a great tool for traders. They display important information in the chart, so the trader can quickly get a good idea of which context he/she is trading in.

Creating strategies based totally or partially on indicators can provide you with good entry and exit points. Some traders even try automating this process to avoid certain issues that can sabotage our strategies like emotions and overtrading.