What is a technical indicator?
Technical indicators are heuristic or pattern-based signals generated by price, volume and/or open interest in a security or contract, used by traders who follow technical analysis.
By analyzing historical data, technical analysts use indicators to predict future price movements. Examples of common technical indicators include Relative Strength Index (RSI), Money Flow Index (MFI), Stochastic, Moving Average Convergence Divergence (MACD), and Bollinger Bands®.
Key Findings
- Technical indicators are heuristic or mathematical calculations based on the price, volume, or open interest of a security or contract, used by traders who follow technical analysis.
- Technical analysts or chartists look for technical indicators in historical asset price data to determine entry and exit points for trades.
- There are several technical indicators that can be divided into two main categories: overlays and oscillators.
How technical indicators work
Technical analysis is a trading discipline used to evaluate investments and identify trading opportunities by analyzing statistical trends collected from trading activity, such as price movements and volume. Unlike fundamental analysts, who attempt to estimate the intrinsic value of a security based on financial or economic data, technical analysts focus on price movement patterns, trading signals, and various other analytical charting tools to assess the strength or weakness of a security.
Technical analysis can be used for any security with historical trading data. This includes stocks, futures, commodities, fixed income, currencies and other securities. In this lesson, we will generally analyze the stocks in our examples, but keep in mind that these concepts can be applied to any type of security. In fact, technical analysis is much more common in the commodity and Forex markets, where traders focus on short-term price movements.
Technical indicators, also known as “techs”, focus on historical trading data such as price, volume and open interest rather than business fundamentals such as earnings, revenue or profit margins. Technical indicators are typically used by active traders as they are designed to analyze short-term price movements, but long-term investors can also use technical indicators to determine entry and exit points.
Types of indicators
There are two main types of technical indicators:
- Overlays: Technical indicators, using the same scale as prices, appear on top of prices on a stock chart. Examples include moving averages and Bollinger Bands®.
- Oscillators: Technical indicators that fluctuate between a local minimum and maximum are located above or below the price chart. Examples include the stochastic oscillator, MACD or RSI.
Traders often use many different technical indicators when analyzing securities. With thousands of different options, traders must choose the indicators that work best for them and become familiar with how they work. Traders can also combine technical indicators with more subjective forms of technical analysis, such as looking at chart patterns, to come up with trading ideas. Technical indicators can also be included in automated trading systems given their quantitative nature.
Example of technical indicators
The following chart shows some of the most common technical indicators, including moving averages, RSI and MACD.
In this example, 50- and 200-day moving averages are plotted on top of the prices to show where the current price is relative to its historical averages. In this case, the 50-day moving average is higher than the 200-day moving average, indicating that the overall trend is positive. The RSI above the chart shows the strength of the current trend – in this case, the neutral level of 49.07. The MACD below the chart shows how the two moving averages have converged or diverged—in this case, slightly bearish.
