A thorough price and volume analysis could help stock market investors to enter an undervalued security at the right time and right price. At times the indicators highlight extreme pessimism zone which help the investors to plan a structured entry and eliminate panic reactions. During a structured bull market identifying relatively strong trends could be achieved with the help of technical indicators like Average Directional Index and and Moving averages etc.
Vivek Gupta, CMT, director research, CapitalVia Global Research, said, “Technial analysis help investors in determining the support and resistance levels. This indicates if a stock’s price has dropped lower (support levels) or has climbed higher (resistance levels). Technical indicators always alert a technical analyst if any major price action or/and volatility is about to occur in a stock’s price.”
Top 5 Technical Indicators
1. Relative Strength Indicator (RSI)
The RSI is classified as a momentum oscillator and it measure the magnitude of directional price movements. Momentum is the rate of the rise or fall in price. The indicator has an upper line, typically at 70, a lower line at 30, and a dashed mid-line at 50.
When price moves up very rapidly, at some point it is considered overbought (When the RSI crosses 70). Likewise, when price falls very rapidly, at some point it is considered oversold (When the RSI crosses 30) the level of the RSI is a measure of the stock’s recent trading strength.
Sacchidanand Uttekar, equity technical analyst, Motilal Oswal, said, “RSI is one of the most reliable indicators to ascertain accumulation and distribution phase. As the name states it gauges the strength of the ongoing trend.”
2. Average Directional Index – (ADX)
ADX is used to measure the trend strength and is plotted as a single line with values ranging from 0-100. It helps investors to quantify the strongest zone and maximize the opportunity to build aggressive positions. Increasing ADX value above 20 indicates that the trend is getting stronger while a move above 50 generally indicates exhaustion of the move. It is an effective tool to navigate in a trending market.
3. Moving averages
Moving averages is one of the oldest and most useful technical indicators in technical analysis. Moving shows a trend in a “smoothed” manner and can give reliable signals when used in tandem with other oscillators like MACD and RSI. Simple moving average (SMA), exponential moving average (EMA) and weighted moving average (WMA) are three types of moving averages. For stocks, common time periods for moving averages are 10 days, 21 days, 50 days, 100 days and 200 days.
Gupta of CapitalVia, said, “The most commonly used moving average is the simple moving average (SMA). Single SMAs can be used to identify a trend but we find that dual or triple MA is more powerful when combined together.”
4. Relative Rotation Graphs (RRGs)
RRGs are a unique visualisation tool to analyse trends in relative strength of multiple securities against a common benchmark and against each other. The tool helps identify relative outperformers in any market situation and helps to channel your attention to those areas of the market that deserve it. According to market experts, it helps investors to have a right portfolio mix and participate in securities which are likely to witness relative strong trends.
Bollinger Bands are a technical trading tool created by John Bollinger in the early 1980s. They arose from the need for adaptive trading bands and the observation that volatility was dynamic, not static as was widely believed at the time. The purpose of Bollinger Bands is to provide a relative definition of high and low. By definition prices are high at the upper band and low at the lower band. This definition can aid in rigorous pattern recognition and is useful in comparing price action to the action of indicators.
Gupta said, “Bollinger Bands consist of a set of three curves drawn in relation to securities prices. The middle band is a measure of the intermediate-term trend, usually a simple moving average that serves as the base for the upper band and lower band. The interval between the upper and lower bands and the middle band is determined by volatility, typically the standard deviation of the same data that were used for the average. The default parameters, 20 periods and two standard deviations, may be adjusted to suit your purpose.”