What are Technical Indicators?

What are technical indicators?

Technical indicators are tools that traders use to analyze price and volume data. You’ve probably heard of indicators like RSI, MACD, Bollinger Bands, and Moving Averages, but what do they actually do?

Simply put, technical indicators use mathematical calculations based on a stock’s price and volume to give traders clues about what might happen next. They help traders spot trends, identify momentum, and confirm trading signals.

Think of technical indicators as your trading helpers. Just like a weather app tells you if it's going to rain, technical indicators tell you what might happen next in the market.

However, it’s important to remember that indicators do not analyze a company’s financial health, earnings, or news — they only focus on price action and volume.

On a price chart, indicators appear as lines or extra data points. Some are placed directly on the chart, following price movements, while others are displayed above or below it.

Like this.

While indicators don’t predict the future, they help identify patterns that have occurred before. By analyzing past price movements, you can anticipate potential market changes.

How are technical indicators used?

Indicators can serve different purposes. Some help you identify when prices are too high or too low. Others confirm if a trend is strong or losing momentum.

There are three main ways you can use indicators:

Alert: They notify traders when something significant is happening with price or volume.

Predict: They help traders anticipate where the price might go next.

Confirm: They act as a second opinion to validate price action.

Do technical indicators work?

Technical indicators don’t guarantee anything, but they help traders understand price movements better. Since markets often move in patterns, indicators can help spot those patterns early. However, no indicator is perfect, so many traders use a mix of different indicators along with price action to improve their chances of making the right call.

The key is not to rely on just one indicator but to use them with price action.

The biggest mistakes traders make with indicators

Most beginners use indicators the wrong way. They see an indicator give a “buy” or “sell” signal and immediately take the trade without checking anything else.

This is a mistake! Before using an indicator, always check:

Price Action: What is the stock actually doing?

Volume: Is the move strong or weak?

Market Conditions: Is the market going up or down?

Support & Resistance: Is the price near key levels?

Indicators should support your trade, not decide it for you.

Types of technical indicators

There are many indicators out there, but they generally fall into four categories:

Momentum Indicators – Measure the speed of price movements

These indicators help traders see how strong a move is. If momentum is increasing, the price may continue in that direction. If momentum slows down, it could be a sign of a reversal.

Examples: RSI (Relative Strength Index), MACD (Moving Average Convergence Divergence)

Volatility indicators – measure how much the price is moving

These indicators don’t care about direction; they just show how much the price fluctuates. Higher volatility means bigger price swings, while lower volatility means smaller movements.

Examples: Bollinger Bands, ATR (Average True Range)

Volume indicators – show the strength behind price moves

Volume indicators help traders see if a move is backed by a lot of trading activity or not. A strong trend should have a high volume, while weak trends may have a low volume.

Examples: OBV (On-Balance Volume), Volume Weighted Average Price (VWAP)

Trend indicators – help identify the direction of the trend

These indicators smooth out price action to show whether the stock is in an uptrend, downtrend, or moving sideways.

Examples: Moving Averages, ADX (Average Directional Index)

Let's look at some indicators.

Volume-weighted average price - VWAP

VWAP is the technical indicator that is used to measure the average price of a stock weighted by trading volume over a specific period, typically one trading session.

The Volume Weighted Average Price (VWAP) is calculated by taking the total dollar value of all trades (price multiplied by volume) and dividing it by the total trading volume for that session. Since it considers both price and volume, it provides a more accurate reflection of where most traders have executed their trades.

However, you don’t need to manually calculate it, as trading platforms automatically display the VWAP line on charts.

In simple words

VWAP is like the average price that most traders are paying, but with a twist – it gives more importance to prices where lots of trading happened. Think of it as the "fair" price for the day.

That is how VWAP lines look on the chart.

In simple terms:

• If the price is above VWAP, the market is seen as bullish, meaning buyers are in control.
• If the price is below VWAP, the market is seen as bearish, meaning sellers are in control.

But this doesn’t mean you should blindly buy just because the price is above VWAP or sell just because it’s below. VWAP is best used with other factors like volume and price action.

Understanding VWAP standard deviations

Along with the main VWAP line, you will see upper and lower bands around VWAP. These bands represent standard deviations and help identify potential overbought or oversold conditions.

(Standard deviation is a way to measure how much prices move away from the average price.)

The upper band (VWAP +1 or +2 standard deviations) suggests that the stock is trading above its average value for the session, possibly overbought.

The lower band (VWAP -1 or -2 standard deviations) suggests that the stock is trading below its average value, possibly oversold.

These bands help you see how far the price has moved from VWAP and whether it may revert back.

In other words

• Upper Band = "Whoa, maybe too expensive!" zone
• Lower Band = "Hey, that's a bargain!" zone
• Middle Line = "Just right" zone

Why is VWAP important?

VWAP is a useful tool for both big investors and everyday traders because it helps show whether a stock is trading at a fair price.

Big investors, like hedge funds and institutions, use VWAP to buy and sell large amounts of stock without moving the price too much. Day traders use VWAP to help decide where to enter and exit trades and to see if the market is trending up or down.

VWAP is often called the equilibrium price because it shows the average price that most traders buy and sell during the session.

Key factors to consider when using VWAP

VWAP is best for Intraday trading

VWAP resets at the start of each trading day, meaning it is most useful for day traders. It is not effective for long-term analysis since it only considers one session at a time.

VWAP might not work well after large gaps

If a stock gap is up or down significantly at market opening, VWAP might not provide useful information. A stock opening $20 higher than the previous day, for example, might distort VWAP and make it less relevant for that session.

The slope of VWAP matters

• If VWAP is rising, it suggests strong bullish momentum.
• If VWAP is falling, it suggests strong bearish momentum.
• If VWAP is flat, the market is likely to consolidate, and a strong trend is less likely.

VWAP as support and resistance

VWAP often acts as a dynamic support or resistance level during the session.

• If the price drops to VWAP and bounces, it suggests buyers are stepping in.
• If the price rises to VWAP and is rejected, it suggests sellers are in control.

Relative strength Indicators - RSI

The Relative Strength Index (RSI) is a technical indicator that helps traders measure the strength of a market trend and identify potential overbought or oversold conditions.

In easy words, it's like a thermostat for the market, measuring if it's running too hot or too cold.

RSI works on a scale of 0 to 100:

Above 70: The market is overbought, meaning the price might be too high and could start dropping.Below 30: The market is oversold, meaning the price might be too low and could start rising.

Traders use these levels to find possible buy and sell opportunities.

RSI is usually shown as a separate indicator below a price chart.

How to trade using RSI

RSI can be used in different ways:

Finding overbought and oversold levels

If the RSI drops below 30, it means the market may be oversold, and the price could bounce back up. Traders look for buying opportunities.

If the RSI rises above 70, it means the market may be overbought, and the price could start falling. Traders look for selling opportunities.

Confirming a trend

If a trader thinks the market is in an uptrend, they check if the RSI is above 50 for confirmation.

If a trader thinks the market is in a downtrend, they check if the RSI is below 50 for confirmation.

Spotting trend reversals

If RSI is at an extreme level (above 70 or below 30) and starts moving back towards 50, it may signal a trend reversal.

RSI is a simple but powerful indicator that helps traders understand market strength and find potential reversals. However, RSI should not be used alone. It works best when combined with price action, support & resistance levels, and other indicators.

Average true range - ATR

ATR stands for Average True Range. It’s a volatility indicator that tells you how much an asset typically moves over a specific period. Unlike indicators that try to predict direction, ATR doesn’t tell you whether price will go up or down — it simply shows how much the price is likely to move. That’s why it’s called a volatility indicator, not a directional one.

What does ATR actually show?

ATR looks at the range between the high and low of each candle, then shows the average range over the last X number of candles. You choose what X is.

For example, if you set ATR to 20 on the daily chart, it shows you the average daily range over the past 20 days.

If you choose ATR 14 on a 1-hour chart, it shows you how much the price has moved, on average, per hour over the last 14 hours.

Using ATR in your trading

Here’s how traders use ATR:

Setting stop losses

ATR helps you place smarter stop losses. If your stop is too close, you might get stopped out by normal price movement, not because your idea was wrong.

Let’s say a stock’s ATR is $1.50. That means it often moves $1.50 in a day. If you set your stop just $0.20 away, there’s a good chance you’ll get stopped out for no reason.

Many traders use 1x, 1.5x, or 2x ATR to decide how far their stop should be, depending on their trade style.

Profit targets

ATR also helps you set better profit targets. If a stock is at $50 and the ATR is $2, then expecting it to hit $60 in one day probably isn’t realistic — unless there’s big news.

A better target for a one-day move might be $52. You’re using ATR to understand what’s normal for that stock.

Measuring volatility

The ATR also helps you gauge how much risk is in the market.

When ATR is falling, it means volatility is decreasing — the market is moving less.

When ATR is rising, it means volatility is increasing — the market is moving more.

Just remember: ATR is a volatility indicator, not a directional one. It tells you how much the price is moving, not which way it’s going.

Key takeaways

• ATR tells you how much something moves, not where it’s going.
• Use it to size your stops and targets based on the actual behavior of the stock.
• It’s especially useful in volatile markets or when switching between different timeframes.
• ATR doesn’t give entry or exit signals on its own — it works best when used with price action, structure, or other indicators.

Moving average convergence divergence - MACD

MACD stands for Moving Average Convergence Divergence. It’s a popular technical indicator that helps traders understand:

• Momentum – Is the price speeding up or slowing down?
• Trend changes – Is a reversal possibly coming?
• Trend direction – Is the market moving up or down?

The MACD doesn’t predict the future.

It shows you what’s happening in the market right now, based on past price movements.

Traders use it to confirm trends or spot potential shifts in momentum, especially when the market is gaining strength or losing it.

When you add the MACD indicator to your chart, you’ll usually see three numbers like this:

• The first number is for the faster-moving average.
• The second number is for the slower-moving average.
• The third number is the number of bars used to calculate the moving average of the difference between the faster and slower averages — this becomes the Signal Line.

So if you see 12, 26, 9:

• The 12 represents a moving average of the previous 12 bars.
• The 26 represents a moving average of the previous 26 bars.
• The 9 represents a moving average of the difference between the two moving averages above.

These are the default settings in most charting platforms and are commonly used by traders.

What does the MACD actually show you?

Once you add MACD to your chart, you’ll notice it appears in a box below the price chart. You’ll see:

• A MACD line
• A Signal line
• A Histogram (bars that go above or below a zero line)

Each part of the MACD works together to give you clues about momentum and trend direction. Let’s break each one down simply.

MACD line

The MACD Line is the main line in the indicator. It shows the difference between two moving averages — one short-term and one long-term.

If the MACD Line is:

• ‍Going up → It means momentum is stronger.‍
• Going down → It means momentum is weakening or turning bearish.

This line reacts quickly to price changes, so it’s considered the faster line.

Signal line

The Signal Line is a smoother line that follows the MACD Line. It’s basically a moving average of the MACD Line itself, which moves slower and helps you spot changes more clearly.

Traders watch when these two lines cross:

• If the MACD Line crosses above the Signal Line → momentum might be turning bullish.
• If the MACD Line crosses below the Signal Line → momentum might be turning bearish.

These are called MACD crossovers, and they’re a common way traders spot possible trend changes.

Histogram

The Histogram is just a visual way to show the difference between the MACD Line and the Signal Line.

It plots the distance between the two lines:

• When the MACD Line is above the Signal Line → the histogram bars go up.
• When the MACD Line is below the Signal Line → the bars go down.
• When both lines are close together, the bars are small.

So if the bars are getting bigger, the two lines are moving apart — that means momentum is growing.

If the bars are getting smaller, the lines are getting closer — that means momentum is slowing down.

The histogram gives you a quick way to spot when momentum is picking up or fading, even before a crossover happens.

Common indicator mistakes

The indicator overload

Loading up your chart with 20 indicators is like trying to watch five movies at once – you'll miss everything! Keep it simple with 2-3 max.

The holy grail syndrome

No indicator is perfect – they're tools, not crystal balls. If anyone tells you they have a 100% accurate indicator, they're probably trying to sell you oceanfront property in Nebraska.

The lazy trader trap

Using indicators without understanding price action is like trying to drive just by looking at your dashboard – you need to look at the road, too!

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