Stock Trading Indicators

Stock trading indicators are used by many stock traders, from beginner to advanced. Yet, many traders do not understand the concept of a stock trading indicator and how it affects their trading results.

Let's start with the basic definition of a stock trading indicator.

A stock trading indicator is any kind of analysis that helps you make better decisions about your trades. To be more specific, an indicator is any quantitative measure at a point in time that provides insight into the current state of the economy, an industry, a company, a stock or a commodity.

When it comes to trading the stock market, the online world is full of advice — charts, indicators, and strategies. Everyone thinks they can predict prices. While some strategies are valid, others are complete bunk.

This list sifts through the fluff and gives you real indicators and strategies you can use to make smart decisions on your next trade.

Volume Weighted Average Price (VWAP)

According to Investopedia, to find VWAP values you must add up "the dollars traded for every transaction (price multiplied by the number of shares traded) and then divide by the total shares traded for the day."

It's important to remember that VWAP is a measure of the average price that investors are paying over the course of a trading session, not a measure of value, per se.

What is VWAP?

The Volume Weighted Average Price (VWAP) is an intraday calculation used to compare where a stock is currently trading relative to its volume-weighted average for the same day.

It is a technical indicator that can be used as a trading strategy for active traders. However, it is also used by larger funds to evaluate the price performance of their investments.

It is important to note that this indicator will be calculated on a daily basis. Each new trading session resets the formula. There are other “multi-day” vwap indicators, however. We discuss anchored vwap in another article.

VWAP Strategy

When choosing a trading strategy, it is important to consider many different factors when deciding how to trade a stock. VWAP (volume weighted average price) strategies are some of the most popular strategies used by traders today.

To understand VWAP it is best to have a good understanding of its components:

Volume - this represents the number of shares that have been traded in the stock over any given time period. This can be measured by the total volume for the day or for any given time span that you wish to measure.

Weighted Average Price - this represents all of the transactions during a period and calculates the average price at which those transactions took place. It does not take into account any open or pending orders.

Price - this is simply the price of the stock based on the last trade that occurred in the market. Price is usually what you will see on a quote screen, but since it only takes into account the last trade, it could potentially be very misleading as to where the price is currently trading in relation to other trades that may have taken place previously in that same time span.

Bollinger Bands (BB) Trading Indicator

John Bollinger created a technical indicator in the 1980s after his own name: "Bollinger Bands". Bollinger Bands resulted from the observation that volatility was dynamic, not static as was widely believed at the time.

The Bollinger Bands' price structure consists of three lines. Knowing these will help you read Bollinger Bands:

A simple moving average (middle band) is used to identify the intermediate-term trend, usually 20 periods.
An upper band (upper Bollinger band) is calculated by adding a standard deviation (typically 2) multiplied by a smoothing constant (usually 20 periods) to the moving average.
A lower band (lower Bollinger band) is calculated by subtracting a standard deviation times a smoothing constant from the moving average.

Bollinger Bands Strategy

A Bollinger Bands strategy is commonly used to identify potential trading opportunities using a technique called percent-b, which uses the relationship between price and the upper and lower bands to identify crowding conditions that might foreshadow a significant move in either direction.

Bollinger Bands can also be used for reversals, squeezes, and snapbacks to the middle of the bands. Here are just a handful of Bollinger bands strategies you can employ in your trading:

Double Bottoms
Reversals
Riding the Bands
Bollinger Band Squeeze
Snapback to the Middle of the Bands
Trading inside the Bands

We cover these Bollinger bands strategies more in-depth in our tutorial found here.

Moving Average Convergence Divergence (MACD)

The Moving Average Convergence Divergence (MACD) indicator was developed in the late 1970s by Gerald Appel. Traders use the MACD indicator to identify changes in momentum and the direction of a trend.

MACD is another very popular technical indicator in stock trading, so it is important to have an understanding of how it works and what it shows.

What is Moving Average Convergence Divergence

Moving Average Convergence Divergence (MACD) is a trend indicator. It shows the relationship between two moving averages and the price of a stock. You could also consider it a momentum indicator.

By default, the MACD is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA (though these settings can be customized). A nine-day EMA of the MACD is what we call the "signal line". This is plotted on top of the MACD and usually serves as a trigger for buy or sell signals.

The MACD indicator can be used to identify and confirm trends, time turning points, and gauge momentum. It often foretells a change in the strength, direction, and momentum of a stock.

MACD Indicator

The MACD indicator is generally used in conjunction with other indicators or chart patterns to provide trade entries and exits. It is based on three time-series moving averages.

a fast-moving average (EMA)
slow-moving average (EMA)
the difference between them, which is displayed as a line and histogram

The fast-moving average is calculated with a shorter timeframe than the slow-moving average; this difference allows for changes in price to be displayed quickly.

Fibonacci Trading Indicator

Fibonacci trading is one of the more popular stock trading indicators. Oftentimes, you’ll see Futures, Forex, and stock markets react to Fibonacci numbers and levels really well.

The widespread availability of the Fibonacci number sequence can be applied to just about any market in order to determine how far the price might travel in a given timeframe.

However, while the fact that this method works is not really in dispute, there are a variety of different ways that Fibonacci numbers can be applied to the price action on any given chart. And as with any other trading approach, some of these methods will work better than others.

What is Fibonacci Trading?

Fibonacci trading involves using numbers found in the Fibonacci sequence to identify potential levels of support and resistance in financial markets. These levels are often areas where traders can place their trades as well as exit trades.

Fibonacci Trading Strategy

The Fibonacci trading strategy is a method of predicting future price movements based on the mathematical relationships discovered by mathematician Leonardo Fibonacci in the 13th century.

Traders use these ratios to create a Fibonacci trading strategy based upon retracements and extensions in an effort to enter and exit positions at key turning points in the market. When combined with other technical indicators, such as moving averages or oscillators, Fibonacci trading can become even more effective.

Traders using this method will look for patterns between high and low prices on a chart that follow the same pattern as the Fibonacci number sequence. Traders may use Fibonacci ratios as a tool to help determine optimal entry points into markets.

Fibonacci Sequence for Stocks

The Fibonacci sequence for stocks is a series of numbers where a number is found by adding up the two numbers before it. Starting with 0 and 1, the sequence goes 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, and so forth.
The formula looks like this:

xn = xn-1 + xn-2

These proportions are often found throughout nature and are known as the Golden Ratio or Golden Mean. It has been used to describe natural phenomena such as nautilus shells and spiral galaxies.

A Fibonacci retracement uses key Fibonacci levels as support and resistance before it continues in the original direction of a trend. Fibonacci retracement levels are plotted with these same key numbers identified by Leonardo Fibonacci in the 13th century.

Pivot Points

Pivot points are used by traders as a predictive indicator and denote levels of technical significance. When used in conjunction with other technical indicators such as support and resistance or Fibonacci, pivot points can be an effective trading tool.

What Are Pivot Points in Trading?

At a very basic level, Pivot points are support and resistance levels. They are calculated by using the open, high, low, and close of previous trading days, weeks, or months.

Pivot points consist of a central pivot and three supporting pivot levels below it and three resistance pivot levels above it. These levels can be used as entry or exit points for trades based on whether the market is trending up or down.

There are several different types of pivot point calculations including standard, Fibonacci, Woodie's, Camarilla and Demark. Each type differs slightly in their calculation but the results remain very similar. To get started with trading pivot points, you need to calculate them. However, most charting tools do this for us in real-time now.

One unique aspect about Pivot points is that they are a "leading" indicator as opposed to a lagging indicator. This just means that traders can use the indicator to gauge potential turning points in the market ahead of time.

Pivot Points Trading Indicator

Pivot points are technical analysis tools that traders use to identify potential support and resistance levels. It is a trading indicator that can be used on all time frames, but they are particularly useful for shorter time frames where price action is more erratic and less predictable.

Pivot points are determined using the high, low, and close prices of a defined period, i.e day, week or month. In simple words, the pivot point is the average of the high, low, and close. However, we also calculate a series of support and resistance levels which are equally spaced above and below the pivot point.

These support and resistance levels help to determine how far the price could potentially move either upward or downward. This makes pivot points a very useful trading indicator.

The most common pivot point levels are taken from a daily chart. On a daily chart, the current day's pivot point is determined by the price action of the previous trading day. Based on the current day's pivot point levels, you will need to use a daily chart to get an accurate level for that day.

Stock Chart Trading Patterns

Stock Patterns

When you're trading stocks, it's important to know how to read stock patterns. The patterns we’ll describe below are some of the most common seen by traders when evaluating a stock chart.

Patterns can form with one candle or a series of candles and can be seen on any time frame from an intraday chart up to weekly and monthly charts. The following are some examples of stock patterns that traders use:

Ascending triangle
Symmetrical triangle
Descending triangle
Cup and handle
Double bottom
Double top
Head and shoulders top/head and shoulders bottom

Trading Patterns

Patterns are recognized through implicit learning. Over time, you’ll pick up on these patterns just as all the traders who’ve gone before you.

Trading patterns come in many different shapes and forms, but they’re all simply historical analogs of stock price movements. It’s your job to attempt to forecast its future movement. Chart patterns can include things like flag patterns, trendlines, and triangles.

That being said, patterns aren't perfect, and nothing about trading is guaranteed. However, there's a lot of money to be made when you have some idea about which way a stock is going to move before it actually moves in that direction.

Flag Patterns

Flags are usually thought of as bullish continuation patterns. Flags form when a stock moves strongly upward and then consolidates in a tight trading range.

The flag pattern is created by two parallel trend lines that slope against the previous trend. The two lines should act as support and resistance while the stock consolidates.

Generally speaking, there should be at least five candlesticks between the trend line breakouts. Flag patterns usually occur opposite the trend lines, in a sense: a break out of a flag pattern signals the end of a corrective move and the resumption of the trend.

For more on flags and pennants, check out our three favorite flag trading strategies

Falling Wedge Pattern

The Falling Wedge Pattern is a bullish reversal chart pattern that can be seen on any chart time frame. The pattern consists of three price points, with the first price point being the highest and the third price point being the lowest of the three price points.

Moving Averages

What Are Moving Averages

A moving average calculates the average price of a security over a specified number of periods. So if you wanted to calculate the 200-day moving average then you would add up the prices of the last 200 days and divide this sum by 200.

Because moving averages are lagging indicators, they will always be behind the price action. This is why you'll sometimes see traders refer to them as trend-following indicators. The longer the period for the moving average, the greater the lag between it and the spot price will be (check out this video for how to use simple moving averages).

Trading with the Simple Moving Average | 27

For example, if we were looking at the closing price for the last 50 days, we would add up the last 50 closing prices and then divide by 50 to get the average closing price for those 50 days (this is called a "simple" moving average). Thankfully, most chart indicators do this for us, and simply plot the value as a line.

There are four popular types of moving averages:

Simple (also referred to as Arithmetic)
Exponential
Weighted
Linear Regression

Simple moving averages give equal weighting to each price in the period whereas exponential moving averages reduce this weighting over time. The type of moving average you use is entirely up to you. Models that incorporate long-term moving averages into their forecasts are usually more successful than models that incorporate only short-term moving averages.

Again, this will all depend upon your strategy and how frequently you trade.

50-Day Moving Average

The 50-period moving average is perhaps the most popular trading indicator. When the price crosses above a moving average, it can be used to indicate that you should enter a long (buy) position. Likewise, when the price crosses below a moving average, it can be used to indicate that you should enter a short (sell) position.

The 50-day moving average is often used by longer-term traders to see when a stock is trending. It displays the average closing price over the last 50 days or 50 periods. The 200-day moving average is the average closing price over the last 200 days.

When you take longer and shorter-term moving averages like the 50-day and the 200-day and cross them on a chart, it often represents a long-term momentum shift. Trend traders will often use these to enter and exit positions. We discuss the Golden Cross more in-depth here.

Best Moving Averages for Day Trading

Moving averages are often cited as the Holy Grail of technical analysis. They can be used to identify trends, spot reversals, and find support and resistance levels. But did you know that they can also be used to identify high probability day trades? If you're a day trader, moving averages can be your best friend or your worst enemy.

While moving averages are great at identifying the trend, they can also cause you to get shaken out of a position right before the next move.

A common question that comes up is, "What is the best moving average?" The answer depends on your goals as an investor or trader. The answer also depends on your time frame.

For example, A 20-period SMA will be much more useful on a shorter time frame trade idea because a shorter moving average responds more quickly to changes in price action. In contrast, a 50- or 200-period moving average may better suit the longer-term trader.

How to Use Moving Averages

The moving average is used to help smooth out some of the noise in price changes and give a clearer picture of what's going on in a stock's price history.

Moving averages are often used in conjunction with other technical indicators such as MACD or RSI to help confirm trends or trend reversals. The concept is simple: take a regular price chart and smooth it out by creating a series of averages. Then, you plot that data on top of the price information.

The most common applications of moving averages identify key support and resistance levels as well as trends. We discuss our 20 moving average pullback strategy here. It’s definitely worth a read.