Technical Analysis Indicators

Why This Matters

Technical analysis indicators form the foundation of active trading strategies and appear throughout your investments course when discussing market efficiency, behavioral finance, and portfolio management. You're being tested on your ability to distinguish between trend-following indicators, momentum oscillators, and volume-based tools—and more importantly, understanding when each type provides meaningful signals versus noise. These concepts connect directly to the Efficient Market Hypothesis debate: if markets are truly efficient, technical indicators shouldn't consistently generate alpha.

Don't just memorize indicator names and formulas. Know what market condition each indicator measures (trend strength, momentum, volatility, or volume), how traders interpret signals (overbought/oversold, crossovers, divergences), and why combining different indicator types strengthens analysis. Exam questions often ask you to identify which indicator best suits a particular trading scenario or to explain why certain signals might generate false positives.

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Trend-Following Indicators

These indicators help traders identify and confirm the direction of price movements over time. They work best in trending markets but can generate false signals during sideways or choppy price action.

Moving Average (MA)

• Smooths price data over a specified period—the Simple Moving Average (SMA) weights all prices equally, while the Exponential Moving Average (EMA) gives more weight to recent prices
• Crossover signals occur when a shorter-term MA crosses above (bullish) or below (bearish) a longer-term MA, indicating potential trend changes
• Dynamic support and resistance levels—prices often bounce off major moving averages like the 50-day or 200-day SMA

Moving Average Convergence Divergence (MACD)

• Shows the relationship between two EMAs—calculated as the 12-period EMA minus the 26-period EMA, with a 9-period signal line
• Crossover trading signals occur when the MACD line crosses above (buy) or below (sell) the signal line
• Divergence warnings—when price makes new highs but MACD doesn't, this bearish divergence suggests weakening momentum and potential reversal

Ichimoku Cloud

• Comprehensive trend system providing support, resistance, trend direction, and momentum in a single visual display
• Five components: Tenkan-sen, Kijun-sen, Senkou Span A, Senkou Span B, and Chikou Span—the "cloud" between Senkou Spans shows support/resistance zones
• Price above the cloud indicates bullish conditions; price below indicates bearish—cloud thickness reflects support/resistance strength

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Momentum Oscillators

Oscillators measure the speed and magnitude of price changes, typically bounded between fixed values. They excel at identifying overbought and oversold conditions, signaling potential reversal points.

Relative Strength Index (RSI)

• Bounded oscillator ranging from 0 to 100—readings above 70 indicate overbought conditions, below 30 indicate oversold
• Momentum measurement calculated using average gains versus average losses over a specified period, typically 14 days
• Divergence signals—when price makes new highs but RSI doesn't, expect potential trend weakness or reversal

Stochastic Oscillator

• Compares closing price to the price range over a specific period—measures where the close falls within the high-low range
• Overbought above 80, oversold below 20—more sensitive than RSI, generating more frequent signals
• %K and %D lines create crossover signals similar to MACD, useful for timing entry and exit points

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Volatility Indicators

These tools measure the degree of price variation, helping traders anticipate breakouts and assess risk. Volatility indicators don't predict direction—they measure the magnitude of potential moves.

Bollinger Bands

• Three-band structure: middle band is a 20-period SMA, outer bands are $\pm 2$ standard deviations from the middle
• Band squeeze indicates low volatility and potential for an imminent breakout—the direction isn't predicted, just that a significant move is likely
• Price touching bands doesn't automatically signal reversal—in strong trends, prices can "walk the band" for extended periods

Average Directional Index (ADX)

• Measures trend strength from 0 to 100 without indicating direction—values above 25 suggest a strong trend, below 20 indicates weak or no trend
• Paired with +DI and -DI to determine trend direction: +DI above -DI signals uptrend, -DI above +DI signals downtrend
• Rising ADX confirms trend strengthening; falling ADX suggests trend exhaustion regardless of price direction

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Volume-Based Indicators

Volume indicators analyze trading activity to confirm price movements. The principle: sustainable price moves should be accompanied by corresponding volume—price changes on low volume are suspect.

On-Balance Volume (OBV)

• Cumulative volume indicator—adds volume on up days, subtracts volume on down days to create a running total
• Accumulation vs. distribution—rising OBV indicates buying pressure (accumulation), falling OBV indicates selling pressure (distribution)
• Divergence signals—if price rises but OBV falls, smart money may be distributing shares, warning of potential reversal

Volume-Weighted Average Price (VWAP)

• Calculates average price weighted by volume—formula: $\text{VWAP} = \frac{\sum(\text{Price} \times \text{Volume})}{\sum \text{Volume}}$
• Institutional benchmark—traders buying below VWAP or selling above VWAP consider their execution favorable
• Intraday support/resistance—price often gravitates toward VWAP, making it a key level for day traders

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Price-Level Indicators

These tools identify specific price levels where buying or selling pressure may emerge. They're based on the principle that historical price action creates psychological and technical barriers.

Fibonacci Retracement

• Key retracement levels: 23.6%, 38.2%, 50%, 61.8%, and 100%—derived from ratios in the Fibonacci sequence
• Anticipates pullback depths—in an uptrend, traders expect support at these percentage retracements of the prior move
• Self-fulfilling tendency—because many traders watch these levels, they often become significant support/resistance points

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Quick Reference Table

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Self-Check Questions

1. Which two oscillators both identify overbought/oversold conditions, and what threshold differences distinguish their signals?

2. A stock's price makes a new 52-week high, but both RSI and OBV fail to confirm with new highs. What does this divergence suggest, and which indicator category does each represent?

3. Compare and contrast how Bollinger Bands and ADX measure market conditions—what does each tell you, and what does each not tell you?

4. If you're an institutional trader trying to assess whether your buy order executed at a favorable price, which indicator would you use as a benchmark, and why?

5. FRQ-style: A trader observes a Bollinger Band squeeze followed by a MACD bullish crossover. Explain what each signal indicates and why combining these two indicator types (volatility + trend) provides stronger confirmation than either alone.