Short Term Trading – Technical Indicators
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. 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.
#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 use longer time periods in moving averages with the most common duration is 200 days. There are different types of moving averages which include: simple, exponential, weighted, and smoothed moving average. 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).
#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.
#3 – Stochastics
This is a 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.