Three of the Best Technical Tools for Trading

When it comes to technical analysis, it’s very easy to become overwhelmed with the shear number of indicators. Everything from Bollinger Bands and MACD, to moving averages and accumulation/distribution lines can make even the most seasoned pros a bit cross-eyed and batty after awhile.

However, with practice, it’s becomes easier.

Here are three of the most popular indicators to be well aware of.

No.1 - Simple Moving Average (SMA)

The simple moving average (SMA) gives you the daily average of the last x number of days.

Many traders rely on the 20-day, 50-day and 200-day moving averages the most and are used as support and resistance lines. Crossovers of such moving averages can also tell us when it’s a good time to buy or even sell along the way.

For example, if the 50-day moves above the 200-day moving average, we have a golden cross, or a bullish signal for a higher price. Or, let’s say the 50-day drops below the 200-day.  In this case, we have a death cross, or a bearish signal.

For example, in early 2016, we can see the 50-day break above the 200-day – a golden cross that gave way to a significant rally from 18,000 to more than 26,000 on the Dow Jones. 

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Or, if we’re trying to identity a long-term trend, a moving average, such as the 200-day moving average can show us support. The 200- day is commonly used in stock trading to determine the general market trend. As long as a stock's price remains above the 200 SMA, a stock or index is generally considered to be in an uptrend. If a stock or index breaks below the 200-day, an argument can be made for a change of trend, possibly to the downside.

For example, we can see how well the iShares NASDAQ Biotech ETF (IBB) held its 200-day moving average to the upside since the middle of 2013 to the middle of 2015. Once the ETF broke through the 200-day, the trend changed.

No. 2 - Accumulation/Distribution Line (A/D Line)

When the A/D line is a momentum indicator that is associated with changes in both price and volume. It’s based on the idea that the more volume that accompanies a move in the stock itself, the more significant the move. 

Divergences in the A/D line and the stock can tell us a change in direction of stock price may be imminent. For example, if the price of the stock is moving higher, but the A/D line is moving lower, it can imply the direction of the stock may soon shift lower.

When both the price of stock and A/D are making higher highs, the uptrend is likely to continue. When both the price of the stock and A/D are making lower lows, the downtrend is likely to continue. When the price of the stock makes new highs and the A/D fails to do so, too, the uptrend could soon fail. That’s known as negative divergence.

When the price of the stock makes new lows and the A/D doesn’t follow suit, the downtrend may soon peter out and reverse.  This is known as positive divergence.

No. 3 – Relative Strength (RSI) Momentum Indicator

The Relative Strength Index (RSI) is a momentum indicator that highlights oversold and overbought conditions on a range of zero to 100. The closer RSI gets to its 70-line, the more overbought the stock is considered to be. The closer RSI gets to its 30-line, the more oversold the stock is considered to be.

Let’s look at Amgen (AMGN) for example.

Notice what happens each time RSI moves to or above its 70-line, the stock gets overbought. Shortly after, the stock begins to pivot and pull back. Or look at what happened each time, RSI fell to or below its 30-line, the stock again pivots and changes direction.

While there are hundreds of technical analysis tools we can use, these are three to be very well aware of as you trade stocks, indices, and ETFs.

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