On-Balance Volume

On-Balance Volume

Technical indicators are used by traders to gain insight into the supply and demand of securities. Indicators, such as volume, provides clues as to whether a price move will continue. In this way, indicators can be used to generate buy and sell signals. In this slideshow, you'll learn about seven technical indicators to add to your trading toolkit. You don't need to use all them, rather a pick a few that you find help in making better trading decisions.

First up, use the on-balance volume indicator (OBV) to measure the positive and negative flow of volume in a security over time.

The indicator is a running total of up volume minus down volume. Up volume is how much volume there is on a day when the price rallied. Down volume is the volume on day when the price falls. Each day volume is added or subtracted from the indicator based on the whether the price went higher or lower.

When OBV is rising it shows that buyers are willing to step in and push the price higher. When OBV is falling, the selling volume is outpacing buying volume which indicates lower prices. In this way it acts like a trend confirmation tool. If price and OBV are rising, that helps indicate a continuation of the trend.

Traders who use OBV also watch for divergence. This occurs when the indicator and price are going in different direction. If the price is rising, but OBV is falling, that could indicate that trend is not backed by strong buyers and could soon reverse.

Accumulation/Distribution Line

One of the most commonly used indicators to determine the money flow in and out of a security is the accumulation/distribution line (A/D line).

It is similar to the on-balance volume indicator (OBV) but, instead of only considering the closing price of the security for the period, it also takes into account the trading range for the period and where the close is relation to that range. If a stock finishes near it high, the indicator gives volume more weight than if it closes near the mid-point of its range. The different calculations means OBV will work better in some cases and A/D will work better in others. 

If the indicator line is trending up it shows buying interest, as the stock is closing above the halfway point of the range. This helps confirm an uptrend. 

If A/D is falling, that means the price is finishing in the lower portion of its daily range and thus volume is considered negative. This helps confirm a downtrend. 

Trader using the A/D line also watch for divergence. If the A/D starts falling while the price is rising, that signals the trend is in trouble and could reverse. Same if the price is trending lower and A/D starts rising. That could signal higher prices to come.

For additional reading, see Trend-Spotting With the Accumulation/Distribution Line.)

Average Directional Index

The average directional index (ADX) is a trend indicator used to measure the strength and momentum of a trend. When the ADX is above 40, the trend is considered to have a lot of directional strength, either up or down, depending on the direction price is moving.

When the ADX indicator is below 20, the trend is considered to be weak or non-trending (for additional reading, see ADX: The Trend Strength Indicator).

The ADX is the main line on the indicator, usually colored black. There are two additional lines which can be optionally shown. These are DI+ and DI-. These lines are often colored red and green respectively. All three lines work together to show the direction of the trend as well as the momentum of the trend.

  • ADX above 20 and DI+ above DI-. That's an uptrend.
  • ADX above 20 and DI- above DI+. That's a downtrend.
  • ADX below 20 is a weak trend or ranging period, often associated with the DI- and DI+ rapidly crisscrossing each other.

Aroon Indicator

Aroon is a technical indicator used to measure whether a security is in a trend, and more specifically if the price is hitting new highs or lows over the calculation period (typically 25).

The indicator can also be used to identify when a new trend is set to begin. The indicator is comprised of two lines: an Aroon-up line and an Aroon-down line.

When Aroon-up crosses above the Aroon-down that is the first sign of a possible trend change. If the Aroon-up hits 100 and stays relatively close to it while the Aroon-down stays near zero, that is positive confirmation of an uptrend.

The reverse is also true. If Aroon-down crosses above Aroon-up and stays near 100, that indicates the downtrend is in force (for additional reading, see Finding The Trend With Aroon).

MACD

The moving average convergence divergence (MACD) indicator helps trades see the trend direction, as well as the momentum of that trend. It also provide a number of trade signals.

When the MACD is above zero, the price is in an upward phase. If the MACD is below zero, it has entered a bearish period. 

The indicator is composed of two lines. The MACD line, and a signal line which moves slower. When MACD crosses below the signal line it indicates price is falling. When the MACD line crosses above the signal, price is rising. 

Looking at which side of zero the indicator is on aids in determining which signals to take. For example, if the indicator is above zero, watch for the MACD to cross above the signal line to buy.

If the MACD is below zero, the MACD crossing below the signal line may provide a possible short trade (for additional reading, see Exploring Oscillators and Indicators: MACD).

Relative Strength Index

The relative strength index (RSI) has at least three major uses. The indicator moves between zero and 100, plotting recent price gains versus recent price losses. The RSI levels therefore help in gauging momentum and trend strength. 

The most basic use of an RSI is as an overbought and oversold indicator. When RSI moves above 70 the asset is considered overbought and could decline. When the RSI is below 30 the asset is oversold and could rally. Making this assumption is dangerous though, therefore some traders wait for the indicator to rise above 70 and then drop below before selling, or drop below 30 and then rise back above before buying. 

Divergence is another use. When the indicator is moving in a different direction than the price it shows that the current price trend is weakening and could soon reverse (for further reading, see Divergence: The Trade Most Profitable)

A third use for the RSI is support and resistance levels. During uptrends, a stock will often hold above the 30 level and frequently reach 70 or above. When a stock is in a downtrend, the RSI will typically hold below 70 and frequently reach 30 or below.

Stochastic Oscillator

The stochastic oscillator is an indicator that measures the current price relative to the price range over a number of periods. Plotted between zero and 100, the idea is that when the trend is up the price should be making new highs. In a downtrend, the price tends to makes new lows. The stochastic tracks whether this is happening.  

The stochastic moves up and down relatively quickly, as it is rare for the price to make continual highs keeping the stochastic near 100, or continual lows keeping the stochastic near zero. Therefore, the stochastic is often used as an overbought and oversold indicator. Values above 80 are considered overbought, while levels below 20 are considered oversold. 

Consider the overall price trend when using overbought and oversold levels. For example, during an uptrend, when the indicator drops below 20 and rises back above it, that is possible buy signal. But rallies above 80 are less consequential because we expect to see the indicator move to 80 and above regularly during an uptrend. During a downtrend, look for the indicator to move above 80 and then drop back below to signal a possible short trade. The 20 level is less significant in a downtrend.

Tools Of The Trade: Conclusion

The goal of every short-term trader is to determine the direction of a given asset's momentum and to attempt to profit from it. There have been hundreds of technical indicators and oscillators developed for this specific purpose, and this slideshow has provided a handful that you can start trying out. Use the indicators to develop strategies, or consider incorporating them into your current strategies. To determine which ones to use, try them out in a demo account. Pick the ones you like the most, and leave the rest.