5 Important Tools Used In Technical Analysis For Trading

5 Important Tools Used In Technical Analysis For Trading

1. On-Balance Volume (OBV)

On-balance volume (OBV) denotes whether there is a positive or negative volume pressure, resulting in a rise or fall in stock prices. As a result, it develops a link between price and volume change. Increased OBV suggests more buyers, resulting in positive volume pressure and higher pricing. In contrast, a dropping OBV suggests more sellers, implying negative volume pressure and lower prices.

Calculating OBV:

OBV takes into consideration the closing price of the stocks.

If today’s closing price > yesterday’s closing price then, OBV = Previous OBV +Today’s Volume

If today’s closing price < yesterday’s closing price then, OBV = Previous OBV -Today’s Volume

If today’s closing price = yesterday’s closing price then, no change in OBV

According to OBV, if trade volume increases without a significant change in stock prices, prices are predicted to move higher or lower, depending on transaction volume. As a result, it aids in the prediction of price patterns. When volume and price trends diverge, traders must be cautious. When prices rise but OBV falls, it indicates that the trend is lacking in strong purchasers and is likely to revert.

2. Accumulation/ Distribution(A/D) Line

To determine whether a stock is being accumulated or distributed, this indicator looks at both the volume and price of the stock. The accumulation of stock reflects the demand for it, whereas the distribution of stock demonstrates the supply of stock. As a result, A/D measures the demand and supply of a security by taking an overview of where the price has closed within the period’s range and multiplying it by the volume of the security traded.

As long as the A/D is rising, this indicates that there is buying pressure on the stock, which means that the stock closes above the midpoint of the period’s range, indicating that the stock is in an uptrend. However, if the A/D line is falling, it indicates that the stock is under selling pressure as it closes below the midpoint of the period’s range, indicating that the stock is in a downtrend.

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Divergence should also be kept an eye out for by traders. As long as the A/D line is falling while the security price continues to rise, it indicates the possibility of increased distribution, which could signal a decline in the security price. If the A/D indicator is in an uptrend while the security price is in a downtrend, this reflects the possibility of greater accumulation, which could signal a higher security price at some point in the near future.

3. Moving Average Convergence/Divergence (MACD)

MACD is the answer to the question of whether to use a short-term or long-term moving average. It is a movement indicator that displays the difference between the short-term and long-term moving averages. The distinction emphasizes price movement in the recent past versus price movement over a longer period of time. When MACD is in the positive zone, it indicates that prices are likely to rise. When MACD is in the negative zone, it sends a selling signal, indicating that prices are likely to fall. The MACD indicator can provide the following signals.

Buying Signals:

a) The MACD line is above the MACD moving average line, and it moves towards the average line but fails to penetrate it, thus rising upward, supported by the average line’s upward movement.

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b) The MACD line is below the MACD moving average line. It moves towards the average line, successfully penetrates it, and continues to rise upward, supported by the average line’s upward movement.

c) The MACD line is above the MACD moving average line and continues to move upward, supported by the average line’s upward movement.

Selling Signals:

a) The MACD line is below the MACD moving average line, and it moves towards the average line but fails to penetrate it, so it begins to decline, supported by the average line’s downward movement.

b) The MACD line is above the MACD moving average line. It moves towards the average line, successfully penetrates it, and continues to fall, supported by the average line’s downward movement.

c) The MACD line is below the MACD moving average line and continues to fall, supported by the average line’s downward movement.

4. Relative Strength Index (RSI)

The RSI is a momentum and trend strength indicator whose value can range from 0 to 100, and we can use this value to determine whether a security is overbought or oversold. When the RSI exceeds 70, the security is considered overbought, and the RSI is expected to fall. When the RSI falls below 30, the security is oversold, and the RSI is expected to rise. However, this is only an assumption; therefore, traders should exercise caution. When the price and the RSI move in opposite directions, the price trend may reverse. For example, if the price is rising while the RSI is falling, the price is likely to fall, and vice versa. The RSI also indicates levels of support and resistance. During an upward trend, the RSI stays above 30 and usually reaches 70 or higher; during a downward trend, it stays below 70 and usually falls to 30 or lower. To summarize, the RSI compares gains and losses and charts the greater of the two. If the RSI is in an uptrend, the stock gains outnumber the losses on a daily basis for the time period chosen, which is usually 14 days. So, ten days of 15% gain and four days of 1% loss would indicate a significant increase in RSI.

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5. Parabolic SAR

The Parabolic SAR is a technical indicator that determines the price movement’s direction. It is also known as the “Stop and Reverse” system, abbreviated as SAR, because it seeks to identify potential price reversals. It is represented graphically in the chart by a series of dots above and below the candle. When the dots are placed beneath the price bars, it indicates a bullish trend and is interpreted as a buy signal. If the dots are placed above the price bars, this indicates a bearish cycle and a sell signal. When the direction of the dots is reversed, trade signals are produced.