Day trading isn’t for every investor. It demands a lot of time, patience, and tolerance for risk. The best approach for someone interested in steady, long-term gains is a stable, diversified portfolio, but if you’re willing to put in the time, it’s possible to make a much faster profit—and possibly even make a living—by trading stocks on a daily basis.
Technical indicators are statistical tools you can use to improve your chances of trading effectively. But why are they so important, and how can you learn to use them?
Why Use Technical Indicators?
Technical indicators have a few unique advantages:
- Separating emotion. Emotional trading rarely works in a trader’s favor. The best trading decisions are cold and logical, based on math rather than fear or excitement. Technical indicators give you that mathematical, logical perspective.
- Simplifying the decision. There are hundreds of variables to consider when trading stocks, but technical indicators simplify those variables. As you’ll see, many indicators’ roles are to crunch several variables down into a single chart or metric, making your role as decision-maker easier.
- Consistent strategic application. Using a technical indicator consistently also allows you some degree of consistency in your strategic application. In other words, you can apply your strategy the same way with each trade, so you can better evaluate how it’s working.
The Technical Indicators
Now let’s look at some specific technical indicators, and what they can tell you about a stock:
- Keltner channels. First up are Keltner channels, which are designed to help traders spot trends and potential reversals. Relying on volatility and average prices over time to plot an upper and lower bound, the chart also features a prominent middle or “average” line. These three lines move together, resulting in the channel-like appearance of the graph, giving day traders a way to make sense of price change trends—and possibly spot a pullback before it happens.
- The average directional index (ADX). The ADX attempts to measure the strength of a given trend, such as a price increase or decrease. The math behind it is complicated, but it attempts to measure the power behind a given trend, rather than direction or momentum; accordingly, it’s a good way to gauge how important a given directional trend in a stock’s price is.
- On-balance volume. The on-balance volume indicator (OBV) helps investors determine the flow of volume in a stock over time. It incorporates up volume (a stock’s volume during a price rally) and down volume (a stock’s volume during a price fall). A rising OBV is an indication of buyers’ willingness to push the price of a stock higher.
- The accumulation/distribution line. The accumulation/distribution line (A/D line) bears some similarity to the OBV. However, instead of looking at the closing prices of a stock for a given period, it also incorporates the trading range for that period. If a stock closes near the high for that run, volume is given more weight. If this indicator trends up, it’s usually a good indication of buying interest.
- The Aroon indicator. The Aroon indicator is designed to help you determine whether a stock is in a trend (or whether a new trend is ready to begin). Aroon-up lines and Aroon-down lines measure new highs and lows in a calculation period; if those lines cross, it’s typically a sign of a change in trend. If one line hits a high volume consistently, with the other line trending toward zero, it’s an indication of a consistent trend in action.
- The relative strength index (RSI). The RSI fluctuates between 0 and 100 to measure recent price gains and losses. While it can be used to determine divergence, as well as support and resistance levels, its most common purpose is to be used as an overbought or oversold indicator (when RSI moves above 70 or below 30, respectively).
- The stochastic oscillator. The stochastic oscillator evaluates the current price of a stock, compared to its price range over several different periods. When a trend is up, a stock should be reaching new highs, and when it’s down, it should be reaching new lows. At its most basic, the stochastic oscillator tracks whether this is occurring.
Unless you want to do the math by hand, you’ll need an external tool to help you apply these formulas and ideas to individual stocks. You’ll also need to come up with your own trading strategy, using a mix of indicators and intuition to drive your trades.
While day trading is intimidating even to seasoned investors, it’s possible to use as a reliable strategy. With these technical indicators working for you, you’ll be able to make even more logical decisions throughout your career.