Welcome to the last piece of the Stock Market Made Simple blog puzzle. Granted this puzzle has been small in size but it has laid a concise foundation for anyone to take the next step forward in trading the stock market. Our puzzle pieces have covered such topics as candlesticks, opening and closing trades, and support and resistance. In today’s final blog, we present the last piece of the starter puzzle: indicators.
A technical analysis indicator is a mathematical calculation which signals support for entry and exit points of a trade. Indicators as a whole are typically only used as a minor factor for getting in and out of a trade; however, they are a strong supporting force when accompanying other candlestick chart data such as support and resistance lines. One of the most beneficial indicators is the exponential moving average.
Around TradeSmart, we tend to set three exponential moving average lines on our candlestick charts: the ten day moving average, the twenty day moving average, and the fifty day moving average. The exponential moving average lines can confirm when a trend is happening. For example, if the price of a stock is below all three moving average lines, then the stock is dropping in price and trending bearish. If the price of a stock is above all three moving average lines, then the stock is rising in price and trending bullish. However, if the price of the stock is in or around the moving average lines, then the stock is trending sideways with no real trend to trade.
Checking to see where the stock falls in line with your EMAs is a great way to confirm a trend but the primary philosophy behind using the exponential moving average comes into play when the lines of the EMA cross as the crossing lines can be a strong signal to buy or sell. Again, you should avoid using exponential moving averages as your only signal to get into and out of trades, but you can use them as a great confirmation signal to enter and exit your trades.
The second primary indicator to use is stochastics. As with the exponential moving average, stochastics is a mathematical calculation which is derived from a stock’s closing price over a predetermined period of time.
A stochastics indicator will show you when a stock is overbought or oversold. For example, when your stock is overbought, the stochastics lines will cross as they are going down which is a signal to exit your long trade. Conversely, when your stock is oversold, the stochastics lines will cross as they are going up which is a signal to exit your short trades. However, stochastics tends to work better when a stock is trending sideways and at the end of a trend. While it fails to perform strongly at the beginning of a trend, this indicator is highly accurate and a boon to both novice and experienced traders alike.
In closing, indicators are a great way to confirm a trend, confirm entering a trade, or to confirm an exit from a trade. They are simple to use and a vital part of the trader’s tool belt. However, it is best to remember these tools offer support to your trading analysis and you should stay away from making trading decisions based on indicators alone.