One of the most common sources of confusion for traders is: how to time the entries and exits of positions.
Oftentimes this is because they lack one of the most important tools in a trader’s toolkit…
Technical Indicators are like guideposts, they allow for more informed and clear minded decisions to be made in the stock market…..and in this post, we’re going to discuss a few of our favorite ones!
Simple Moving Average (SMA)
The SMA is one of the most useful indicators in determining the price action direction, both in the short and long term.
Why is it useful?
It gives us a clear vantage point of the how bullish or bearish the price is moving…
One of the neat things about it, is that we can use multiple simple moving averages, that give us price strength for different periods of time.
In our case, we like to use two simple moving averages!
The short term SMA line helps us determine the price strength of a stock.
When the price action crosses over the blue line, it means we are seeing short term price strength. When the price action crosses below it, this means we are seeing short term weakness.
The long term SMA line helps us determine the directional strength of a stock. By directional strength, we mean a longer term directional pattern of bullish or bearish behavior.
If you pay close attention, you’ll notice that we have two of these on the chart at the same time…
We can combine these two indicators to give us a better technical reading of the charts, that we wouldn’t otherwise be able to achieve with just one alone.
This indicator acts as a powerful companion tool to the Simple Moving Average.
While on the surface it may seem to perform a lot of the same functions as an SMA, its power lies in the way the information is presented…
While it may be easy to use other indicators to determine if there is price strength…..its not as easy to see the level of the price strength.
To show you why it’s easier, let’s look at the price action for APPL with the MACD indicator in place.
We can clearly distinguish the price strength between the second and third spike. This may seem obvious on the indicator, but its not so clear on the price action itself…
Relative Strength Index (RSI)
As traders we always want to be getting in a stock at a “good deal”, but the million dollar question becomes…..how do we know whether it is?
This is where the RSI comes into play! It tells us whether a security is currently overbought or oversold.
A stock being in an oversold region on the RSI is an indication that the current price is a “good deal”. On the other hand, when a stock is in the overbought region, it means that the stock is likely overpriced from a technical standpoint.
Does this mean you should always buy stocks that are “oversold” and sell stocks that are overbought?
No…..but it is an important factor to consider when look at the overall technical picture.
It’s important to also keep in mind that the price action does not usually hang out in overbought or oversold regions, but rather is somewhere smack in the middle. At these prices the security would not be considered a good or a bad deal from the perspective of the RSI, but it can show us in which direction things are leaning…
While many don’t consider this to be an indicator per se, it gives us an important piece of information necessary for a technical trader to make informed decisions.
There are two main reasons to use a volume indicator…
Firstly, we need a certain base level volume reading in order to have liquidity in the stock.
Why is this important?
Liquidity allows for the ability to more quickly enter into and out of positions. When liquidity is low, it may take minutes to hours to enter/exit a position. Depending on the circumstance this could be detrimental!
A second reason is that volume shows us changes in the amount of buying and selling of a security, which often correlates with the building of momentum in the price action itself.
As with all other indicators, while it’s certainly advantageous to use volume, it is not a be all end all.
The Combined Approach
While we can use all of the indicators separately, the best approach is to use multiple at one time…
In this way, we can stack multiple elevating factors at one time, which has a compounding effect on the strength of a position from a technical standpoint.
Of course, there are many nuances to this, but its important to approach technical analysis with the right understanding and mindset!