Technical Indicator Definition

What is a technical indicator?

Technical indicators are heuristic or pattern-based signals produced by the price, volume, and/or open interest of a security or contract used by traders who follow technical analysis.

By analyzing historical data, technical analysts use indicators to predict future price movements. Examples of common technical indicators include the relative strength index (ROI), Cash flow index (IMF), stochastic, moving average convergence divergence (MACD), and Bollinger Bands®.

Key points to remember

  • Technical indicators are heuristic or mathematical calculations based on the price, volume, or open interest of a security or contract used by traders who follow technical analysis.
  • Technical analysts or chartists look for technical indicators in historical asset price data to judge trade entry and exit points.
  • There are several technical indicators that fall into two broad categories: overlays and oscillators.

How Technical Indicators Work

Technical analysis is a trading discipline used to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Unlike fundamental analysts, who try to assess the intrinsic value of a security based on financial or economic data, technical analysts focus on price movement patterns, trading signals and various other analytical charting tools to gauge a security’s strength or weakness.

Technical analysis can be used on any security with historical trading data. This includes stocks, futures contracts, goods, fixed income securities, currencies and other securities. In this tutorial, we will generally analyze actions in our examples, but keep in mind that these concepts can be applied to any type of security. In fact, technical analysis is much more prevalent in commodities and currencies markets, where traders focus on short-term price movements.

Technical indicators, also known as “technical”, focus on historical trade data, such as price, volumeand open interest, rather than the fundamentals of a business, such as earnings, revenueWhere profit margins. Technical indicators are commonly used by active traders because they are designed to analyze short-term price movements, but long-term investors can also use technical indicators to identify entry and exit points.

Types of indicators

There are two basic types of technical indicators:

  1. Overlays: Technical indicators that use the same scale as prices are plotted above prices on a stock chart. Examples include moving averages and Bollinger Bands®.
  2. Oscillators: Technical indicators that oscillate between a local minimum and maximum are plotted above or below a price chart. Examples include the stochastic oscillator, MACDor RSI.

Traders often use many different technical indicators when analyzing a security. With thousands of different options, traders should choose the indicators that suit them best and become familiar with how they work. Traders can also combine technical indicators with more subjective forms of technical analysis, such as examining chart patterns, to come up with trade ideas. Technical indicators can also be integrated into automated trading systems, given their quantitative nature.

Example of technical indicators

The following table shows some of the most common technical indicators, including moving averagesRSI and MACD.

Image by Sabrina Jiang © Investopedia 2020

In this example, the 50- and 200-day moving averages are plotted above the prices to show where the current price stands in relation to its historical averages. The 50-day moving average is above the 200-day moving average in this case, suggesting that the orient oneself was positive. The RSI above the chart shows the strength of the current trend – a neutral 49.07, in this case. The MACD below the chart shows how the two moving averages have converged Where diverge– slightly bearish, in this case.

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