Franklin Templeton is one of the best investors of all time. He is the founder of Franklin Templeton investments, a global leader in fixed income and equities trading.
One of his well-known observation was that in the financial market nothing new happens. Everything that happens has happened before. Therefore, any intelligent investor needs to look at history and then make decisions based on this.
This has also been observed by Ray Dalio who runs the biggest hedge fund in the world. In his theory of how the economic machine works, Dalio notes that the market is cyclical. This means that the market will move up and down most of the times.
And here we come to the point of our post. Technical indicators are essential tools in helping a trader identify the different market cycles.
In this article, we will look at some of the most important technical indicators that any trader should use for Short Term Trading.
Why Focusing on the short-term
Generally, there are three main types of traders. First, there are those who focus on the long-term. They analyze their positions and hold them for several weeks or even months. They are mostly concerned with the fundamentals of the financial asset.
Second, there are swing traders who have a near-term view. These traders are known for analyzing the market and finding short term opportunities. These traders buy and hold assets for about 3 to five days.
Finally, there are day traders who believe in opening trades and leaving them open within a day. They are not believers in holding positions overnight.
By focusing on a narrower time frame, we can better take advantage of volatility and the opportunities it presents in the markets (and various assets).
Short term vs long-term
Many traders have found substantial success using these approaches. For example, Warren Buffett has become one of the richest people in the world by investing and holding positions for the long term. Similarly, a trader like Jim Simmons has been successful by holding his positions for a few minutes.
Still, there are several benefits of being a trader than being a long-term investor.
For one, as a day trader, you can take advantage of short-term swings in a financial asset. For example, the chart below shows that the Coca-Cola share price has been in an overall bullish trend between March 2020 and August 2021.
Still, the stock has declined several times during this uptrend. Therefore, day traders have taken advantage of these swings to make money.
Second, day trading eliminates overnight risks. For example, at times, it is common for a stock to crash when it opens. The chart below shows that the stock price of Axsome Therapeutics crashed by more than 40% when it opened. This was a major loss to those who were long the stock.
So, now let us look at some of the top indicators for day traders.
Technical indicators for day trading: which are the best?
1. Moving Averages
A trader must always use Moving Averages to make trading/investment decisions. Moving Averages are used to make trading decisions even by the leading investors around the world.
In Bloomberg television, Mark Burton has a session known as 'battle of the charts'. Most times, he bases his analysis on Moving Averages. Simply stated, if the best investors use these tools, why wouldn’t a normal trader use the tool?
As a day trader, what really matters is the timing and the type of moving average used. Long term investors, for example, use longer time periods in moving averages with the most common duration is 200 days.
There are different types of moving averages which include:
Therefore, it is very important for you to use moving average as a trader. Traders can also gain by combining various durations to make decisions.
For instance, a trader can combine 5 and 10-day Exponential Moving Averages (EMA) to look for, as an example, eventual crossovers.
2. Relative Strength Index (RSI)
RSI is a momentum oscillator which was used by Welles Wilder. This indicator measures the speed and change of price movements between the range of zero (0) to 100.
The indicator is used to indicate periods when an item is overbought or oversold. Generally, it is usually overbought when it goes above 70. It is oversold when it falls below 30.
When an ‘asset’ is overbought, the trader should go ahead and short it while during an oversold position, it should be bought.
This is another momentum oscillator which was developed in 1950. It shows the location of the close relative to the high-low range over a set number of periods.
In simple terms, this oscillator does not follow the price and volume but the speed of the price. In the default, stochastics is usually set at 14 periods. It measures the level of the close relative to the high-low range over a given period of time.
Day traders need to use short term periods. It is usually set between 0 and 100. Readings above 80 show that a security is trading near the period’s range. Readings below 20 show that the security is trading at the low end of the range.
4. Average Directional Movement (ADX)
Average Directional Movement Index (ADX) is made up of the minus directional indicator (-DI) and plus directional indicator (+DI). This indicator was developed by Welles Wilder who created it with the commodity market in mind.
ADX is used to test whether a trend is forming or not. This is particularly very important when one is looking at a breakout. A breakout is important because it enables the trader to enter a trade when the trend is forming.
5. Bollinger Bands
Bollinger Bands is an important technical indicator used by many traders and investors. The indicator was developed by John Bollinger.
The bands are placed above and below the moving average. It is based on the standard deviation which is known to change when volatility increases and decreases.
Many investors use Bollinger bands to make decisions. Bollinger stated that the bands should have between 88 and 89% of price action. Therefore, a move outside the bands is very significant.
Regardless of your trading style, analyzing the market is essential, whether you do it with technical and fundamental analysis, price action or are interested in general sentiment.
For day traders, and anyone who trades at a high frequency, this set of indicators will come in very handy. They are the basics, good for both beginners and experienced users!
External Useful Resources
- Short Term indicators and strategies - Tradingview