In this tutorial we’ll guide you through some of the top technical indicators for beginners. We’re going to show you the most important indicators for technical analysis you should start off learning and becoming familiar with. The technical indicators we’re going to cover are moving averages, relative strength index (otherwise known as the RSI), moving average convergence divergence (also known as the MACD) and Bollinger Bands.
- Moving Averages
- Relative Strength Index (RSI)
- Moving Average Convergence / Divergence (MACD)
- Bollinger Bands
As we touch on each indicator, we’ll also run through a high-level overview of how it’s calculated. However, this tutorial is really about seeing these technical indicators in action, recognizing their signals and learning how to form opinions and trades around them. Alright, let’s jump straight into it and check out some moving averages.
You’ve probably seen these long thin squiggly lines in the background of all the charts that you’ve been watching and researching. They’re so common, they’re pretty much automatically switched on and present in most chart sites nowadays. Depending on the length of the input and your chart’s view, these lines are going to represent the average price of the previous X number of minutes, hours, days or whatever time frame it is that you selected.
Moving averages are one of the most popular and most common basic technical indicators. As such they are on lots of people’s radars when searching for a trade. They also play a part in many other technical indicators as we’ll see later on in this guide on technical analysis for beginners. Moving averages help to remove all the noise that green and red candles in candlestick charts can make. They give you a much smoother view of the previous 10, 20, 50 even 200 candles. This makes it super easy to spot which direction the trend is going in with just a quick glance.
The 50 and 200 pair like we have up on the chart above are very common. The 9-day is also a pretty popular one, particularly for the shorter term day traders or swing traders. It’s advisable to have at least two moving averages in the chart for comparison. In terms of getting long this is really important because you ideally want the shorter term time frame above the longer terms. That’s the 50 day above the 200 in this case. Vice versa, the bears can be said to be calling the shots when the 50-day or the shorter term is below the longer term.
It’s considered very significant when these moving averages cross. We have the ominous “death cross” when the 50-day or the shorter term comes under the longer term. You can see an example in the chart above from August 2015 with the S&P and the massive sell-off. Likewise, when that switches back over and the 50-day crosses above the 200 like in April 2016, we have the “golden cross”. It’s very important to know which side the moving averages are on right now. It can help you tell whether it’s a good time to be getting involved or whether it’s worthwhile just staying out for a little while longer and letting them figure themselves out.
Let’s take a look at XBI. This is the popular biotech index, the ETF. Now if you’re along through the great bull run that we had in biotech back in 2014 and 2015, you might have entered in June or July of 2014, just as the 50-day moving average moved above the 200. This is giving us the “golden cross”, which can be a very good entry signal.
You would have got a great run through the middle of 2015. Then the 50-day moving average turned back, you’re watching for the “death cross”, at which point you’re exiting. You’re taking your profits, certainly not getting long and you’re avoiding all of the sell-off afterwards. You’re then watching for the “golden cross” the following year in 2016, you’re entering around this point and you’re catching the great run then up to where we are today.
Moving averages can also provide great levels of support because they’re watched so closely. You can see an example in the chart above of the weekly S&P. The S&P has been hugging the 50-day moving average for the past six years. There’s only been a couple of mishaps. We can see going back to 2012 that it was bouncing, in 2014 it was bouncing, it broke through in 2015 but then the 200-day moving average moved in and gave some support.
The 50-day moving average came back, the S&P bounced and then this past February and March it’s been a solid reliable indicator throughout the last couple of weeks when we’ve seen the increase in volatility. In terms of picking a point to get long, knowing how reliable a stock’s moving average is, is a very good place to start. Ok, let’s move on to the relative strength index known primarily by its acronym RSI.
Relative Strength Index (RSI)
The relative strength index (RSI) tells you about a stock’s momentum. It’s a great technical indicator for giving us a sense about if a stock is overbought or oversold. The RSI indicator rides up and down between 0 and 100. However, the big numbers you’ve got to remember are 70 and 30. If the RSI is over 70, it’s telling you that a stock is very overbought and increasingly so the higher up it goes. Vice-versa, if the RSI is under 30, in the 20s, the 10s or in very rare occasions in the single figures, you know that a stock is very oversold from a technical point if view.
The RSI is very helpful when it comes to deciding whether to enter a trade or to hold off. Now given we’ve been in a bull market for over eight years, it’s obviously most effective when timing an entry after a dip. For example, looking at the S&P since 2014 in the chart above, we can see that every time the RSI came down towards the 30 level, the S&P was also close to the trough of a dip.
So if you’re looking for signals to buy, timing it with the RSI at 30 or below, would have got you into the bottom of pretty much every sell-off that we’ve had in the last four or five years, right up until last February. The relative strength index is not a good indicator for telling you how to handle a trade once you’re in it, but in fairness you can’t expect the RSI to do everything for you. The RSI is the right technical indicator to be looking at when you’re thinking about getting into a trade. It’s also a great indicator to have around for warning you against getting long as well.
Check out the S&P in the chart above. This past January we had a massive run all month. The RSI popped up well above the 80s and this would have been a huge red flag to anybody wishing to get long. Keeping an eye on the RSI might have helped you avoid taking a position and you’d have missed the massive demolition that we had then in February. So to put it simply, when it’s at its extremes, the RSI is indicating that this underlying stock is more likely to reverse in the short term, than to keep going.
Moving Average Convergence / Divergence (MACD)
Alright, on to the next technical indicator which is the moving average convergence / divergence or MACD. The MACD is also a momentum indicator. It’s very useful for timing your entry and your exit. This indicator is the more complicated, but powerful cousin of the basic moving averages that we were checking out before. The MACD takes typically the 12, 26 and 9-day periods or whatever time frame it is that your chart is on and makes them converge / diverge, as the name suggests, based on the underlying stock.
When you’re starting off with the MACD, all you really have to watch for are the crossovers. You can build really easy and reliable buying or selling indicators from the MACD indicator. We’ll stick with the S&P and just look at it from November through to today in the chart above.
Utilizing the MACD back in November you’d have been long from that point. You’ve been maintaining along all the way through January when we had this negative crossover. You might call it a “death cross” if you want. The shorter time frame moved under the longer term. Taking this as an exit signal, you would have missed all the sell-off that we had at the start of February.
You could have gotten back in at the next crossover, you might be getting back out at the start of March. You’re definitely getting out towards the end of March and missing the choppiness. You’re taking a long position at the start of April, which you’re probably still in today. So you’re in a good position based purely on entering and exiting based on the MACD’s crossovers. You’re catching most of the long moves and you’re avoiding most of the draw downs.
Let’s take a look at some Bollinger Bands. Mr. John Bollinger came up with these back in the 80s and they basically plot a standard deviation move above and below a 20-day moving average. The indicator shows a stock’s volatility, so it makes sense that Bollinger Bands see their biggest moves and their biggest swings on the most volatile of days.
In the chart above we’re looking at Agile Therapeutics, which recently got slammed with their bad trial comments and they fell 80% over a single day. We can see the Bollinger Bands bands blew way out. We can guess what the RSI and the MACD did. There’s a couple of ways to base a trade around this. Shorter term investors and traders might go with the move and get short for a quick trade. Longer term investors might view it as a kind of massive move that just can’t be sustained. They could look to position themselves long for a bounce.
VXX was in a big downtrend in 2016 and 2017 and astute traders would have spotted that every time it popped and tagged the upper Bollinger Band, it was a great short. In the chart above we see it back in September, October, November 2016 and all throughout 2017. It was popping up in April, throughout the summer a couple of times, all the way through to the start of this year.
However, just like the other technical indicators that we’ve talked about already, it can’t be relied upon solely. If you’re watching this coming up to the start of February in the chart above, you would have probably been getting short as it came through the upper band on the last day of trading in January. You would have taken a lot of pain over the coming days. This ties in with the other technical indicators that we’ve covered.
Conclusion: Technical indicators for beginners
The technical indicators we’ve covered here are all based on past price data. They are what’s called backward-looking. They’re easy to learn and can make reading charts really a breeze for beginners. You can utilize these technical indicators to form an opinion or a trading strategy. They can also be the reason to get in or out of a trade. However, ultimately they should be used in conjunction with the trader’s own research and market opinion.
Just like we covered in our article on managing a trade, having a trading plan and sticking to it is vital. Traders can watch technical indicators to help form an opinion, that’s totally fine. But ultimately it’s up to the trader to manage and control the risk via a well worked out trading plan. What are your thoughts on technical indicators? What’s your favorite indicator for technical analysis? Please let us know in the comments below.