As a day trader, your career revolves around making short term trades and taking some quick gains. This can be very profitable for experienced traders and a nightmare for inexperienced traders. The difference between experienced day traders with the inexperienced ones is that the former have mastered key strategies of trading. Some have expertise in fundamental trading while others are experts in technical analysis. Others are experts in the two methods. In this article, I will look at the most appropriate technical indicators for day traders.
Moving Averages (MA) are some of the most commonly used technical indicators because historically, they have done very well. There are 5 main used types of moving averages which include: simple moving averages, exponential moving averages, triangle moving averages, double exponential moving averages, and smoothed moving averages. For day traders using the moving averages, the secret is to use a short duration such as 10 days. Exponential Moving Average reacts faster than other types of moving averages. It is also important to combine a shorter term moving average with longer term moving average. A buy signal comes out when the moving average is below the current price of the asset.
Support and resistance
In investing, a common cliché goes like this: buy low and sell high. This is a fact that if you buy low and sell high, you will make a good profit. However, the challenge comes when identifying the low point to buy and a high point to sell. In many cases, people, including experienced traders buy with the impression that the chart has reached the floor only to find the chart continuing a downward trend. It is for this reason that the concept of support and resistance becomes very important. The figure below shows the concept of support and resistance.
The challenge many traders face is on how to identify the support or resistance. A number of ways have been developed which entail using various technical indicators such as moving averages to judge an asset. The figure below shows a good example of support and resistance in action.
Average Directional Index (ADX)
The Average Directional Index (ADX) is a very important indicator used by traders to identify a trend. The Average Directional Index is derived from the plus directional movement (+) and the minus directional index (-). The directional movement is positive when the current high price subtracted by the previous high is bigger than the previous low subtracted by the current low. On the other hand, the directional movement is negative when the previous low subtracted by the current low is bigger than the current high minus the previous high.
Understanding these concepts is very important for any trader. However, since most trading systems are automated, there is no need for manual calculations.
In ADX, a value less than 30 indicates a weak trend while a value above 25 indicates a strong trend. Therefore, if the ADX value is strong, a trader needs to buy at the pullback sections when the pair retreats. The pullback section will act as the support.
Commodity Channel Index
The Commodities Channel Index (CCI) was created by Donald Lampert in 1980. It is one of the most commonly used technical indicators by day traders because of its accuracy. It is used to identify a trend or warn of extreme conditions by measuring the current price level to an average price over a particular duration of time. When the prices are above their average, the CCI level is usually high. On the other hand, CCI is low when prices are below their average. Therefore, it is an important indicator for overbought or oversold levels.
Quite often, most CCI levels happen between -100 and +100. When these extremes are passed, it is usually an extreme situation which calls for caution when placing trades. A positive CCI value favours bulls while a negative CCI favours bears.
Relative Strength Index
Relative Strength Index (RSI) is an indicator just like CCI that aims to identify overbought and oversold positions. The RSI chart ranges from 0 to 100. When the RSI of a commodity, currency or equity goes above 70, it indicates an overbought position. This overbought position is a good candidate for bears. On the other hand, if the RSI goes down to 30, it might be an indicator that the asset is being oversold.
The figure below shows the RSI index in a EURUSD pair and notice what happens in the marked areas.
By combining these indicators, it is possible for a trader to make huge profits. However, it is important to note that they are not accurate all the time. Before a trader implements any technical indicator, it is very important to know more about it and backtest it.