Understanding Technical Indicators
Learn how to read charts and technical patterns that help predict price movements
What Are Technical Indicators?
Technical indicators are mathematical calculations based on a stock's price, volume, or open interest. Unlike financial indicators that look at a company's business fundamentals, technical indicators focus purely on price movements and trading patterns.
Think of technical analysis as reading the stock's "body language" - patterns in how the price moves can reveal what traders and investors are thinking, and potentially where the price might go next.
1 MACD (Moving Average Convergence Divergence)
What It Is
MACD is one of the most popular momentum indicators. It shows the relationship between two moving averages of a stock's price and helps identify potential buy and sell signals.
Components
MACD Line
The difference between the 12-day and 26-day exponential moving averages. Shows momentum direction and strength.
Signal Line
A 9-day moving average of the MACD line. Crossovers with the MACD line generate trading signals.
Histogram
The difference between the MACD line and signal line. Shows momentum changes visually.
How to Read It
- MACD line crosses above the signal line
- Both lines are below zero and moving upward
- Histogram bars growing positively
- MACD line crosses below the signal line
- Both lines are above zero and moving downward
- Histogram bars growing negatively
In Simple Terms
Imagine two cars driving on a highway. The MACD line is a fast car, and the signal line is slower. When the fast car (MACD) overtakes the slow car (signal line), it suggests the stock price might accelerate upward. When the slow car overtakes, it suggests slowing down or reversal.
2 Candlestick Charts & Price Action
What They Are
Candlestick charts show four key pieces of information for each time period: the opening price, closing price, highest price, and lowest price. Each "candlestick" visually represents this data.
Green/White Candle (Bullish)
Body: The thick part shows the opening (bottom) and closing (top) price.
Wicks/Shadows: The thin lines show the highest and lowest prices during that period.
Meaning: The price closed higher than it opened - buyers were in control.
Red/Black Candle (Bearish)
Body: Shows the opening (top) and closing (bottom) price.
Wicks/Shadows: Same as green candles - highest and lowest prices.
Meaning: The price closed lower than it opened - sellers were in control.
Reading Candlestick Patterns
The size and shape of candles tell a story:
- Long Body: Strong buying or selling pressure
- Short Body: Indecision or consolidation
- Long Upper Wick: Sellers pushed price down from highs
- Long Lower Wick: Buyers pushed price up from lows
- No Wicks (Marubozu): Very strong trend in one direction
In Simple Terms
Think of each candle as a battle between buyers and sellers. The body shows who won (green = buyers, red = sellers), and the wicks show how far each side pushed before the other side fought back. A long green body means buyers dominated; a long red body means sellers dominated.
3 Volume
What It Is
Volume shows how many shares were traded during a specific time period. It's usually displayed as bars at the bottom of price charts.
Why It Matters
Volume confirms the strength of price movements. High volume means many people are trading, which validates the price move. Low volume suggests weaker conviction.
Strong Signals:
- Price increase + high volume = strong uptrend
- Price breakout + high volume = likely to continue
- Volume surge = increased interest/news
Weak Signals:
- Price increase + low volume = might reverse
- Price decrease + low volume = might be temporary
- Consistently low volume = illiquid stock
In Simple Terms
Imagine a voting system. High volume is like many people voting - the result is more meaningful. Low volume is like only a few people voting - the result might not represent the broader opinion. A price move with high volume has more "votes" supporting it.
4 Moving Averages (MA & EMA)
What They Are
Moving averages smooth out price data by creating an average price over a specific number of periods. They help identify trends and potential support/resistance levels.
Simple Moving Average (SMA)
The average closing price over a set number of periods (e.g., 50-day, 200-day). Each period has equal weight.
Exponential Moving Average (EMA)
Similar to SMA but gives more weight to recent prices. Responds faster to price changes.
Common Uses
- Trend Identification: Price above MA = uptrend; below = downtrend
- Support/Resistance: MAs often act as price floors or ceilings
- Crossovers: When a short-term MA crosses a long-term MA, it signals trend changes
- 50-day and 200-day MAs: Widely watched by institutional investors
Golden Cross: 50-day MA crosses above 200-day MA = bullish long-term signal
Death Cross: 50-day MA crosses below 200-day MA = bearish long-term signal
In Simple Terms
Moving averages are like the "center of gravity" for a stock price. If the price is above the MA, it's like a ball rolling uphill (uptrend). Below the MA is like rolling downhill (downtrend). The MA itself can act like a magnet that pulls the price back toward it.
5 RSI (Relative Strength Index)
What It Is
RSI is a momentum oscillator that measures the speed and magnitude of price changes. It ranges from 0 to 100 and helps identify overbought or oversold conditions.
Overbought
70-100
Price may have risen too fast, possible pullback
Neutral
30-70
Normal trading range, no extreme conditions
Oversold
0-30
Price may have fallen too fast, possible bounce
How to Use It
- RSI crosses above 30 from below (recovering from oversold)
- RSI makes higher lows while price makes lower lows (bullish divergence)
- RSI crosses below 70 from above (falling from overbought)
- RSI makes lower highs while price makes higher highs (bearish divergence)
In Simple Terms
Think of RSI as a speedometer for price movement. Above 70 means the price has been accelerating upward too fast (might need to slow down). Below 30 means it's been dropping too fast (might bounce back). It's like a rubber band - stretch it too far one way, and it wants to snap back.
6 Bollinger Bands
What They Are
Bollinger Bands consist of three lines: a middle line (moving average) and two outer bands that represent standard deviations from the middle. They expand and contract based on price volatility.
Upper Band
2 standard deviations above the middle line. Prices touching it may be overbought.
Middle Band
20-period simple moving average. Acts as support/resistance.
Lower Band
2 standard deviations below the middle line. Prices touching it may be oversold.
What They Tell You
- Squeeze: When bands are close together, volatility is low - a big move may be coming
- Expansion: When bands widen apart, volatility is increasing
- Price at Upper Band: Stock may be overbought (in uptrend) or very strong
- Price at Lower Band: Stock may be oversold (in downtrend) or very weak
- Walking the Band: Price staying near upper/lower band indicates strong trend
In Simple Terms
Bollinger Bands are like guardrails on a highway. The price usually stays between them. When the bands are narrow (squeeze), it's like a calm road - but a storm might be coming. When they're wide, it's a bumpy ride with lots of price swings. Touching the outer bands is like reaching the edge - often, the price bounces back toward the center.
Combining Technical Indicators
The real power comes from using multiple indicators together to confirm signals:
Strong Buy Signal Example
- MACD line crosses above signal line
- Price breaks above 50-day moving average
- RSI moves up from oversold (30) to 50
- Volume increases significantly
- Price bounces off lower Bollinger Band
Strong Sell Signal Example
- MACD line crosses below signal line
- Price breaks below 50-day moving average
- RSI drops from overbought (70) to 50
- Volume increases on down days
- Price rejected at upper Bollinger Band
Best Practices for Technical Analysis
✓ Do:
- Use multiple timeframes (daily, weekly charts)
- Confirm signals with volume
- Wait for patterns to complete
- Combine with fundamental analysis
- Practice on paper before real trading
- Keep a trading journal
✗ Don't:
- Rely on a single indicator
- Ignore the overall market trend
- Over-optimize or curve-fit
- Trade based on emotion
- Ignore risk management
- Expect 100% accuracy