Technical indicators, i.e mathematical formulas whose results are represented by curves that provide valuable information to traders, are the basis of technical analysis.
"For me, market analysis is like a tremendous multi-dimensional chess board. The pleasure is purely intellectual." Many traders will relate to this quote from Bruce Kovner. Indeed, technical analysis is the very core of trading. In addition to increased gains in the markets, developing and perfecting your analytical skills offers great intellectual satisfaction. In a quest for constant optimization, the question of the best technical indicator is never far from investors’ preoccupations.
Here is a complete summary of the information you need to find the most suitable and reliable technical indicator for your trading practice.
A technical indicator is a mathematical formula, usually based on the price or volume of a specific financial asset. Usually represented by curves superimposed on the price of an asset on a stock chart, these indicators give the trader information on the price trend. Analysis of technical indicators enable investors to anticipate price fluctuations and trend reversals in the financial markets. The most experienced traders combine indicators with other technical analysis tools to optimize their analysis and maximize their profits.
There are many different technical indicators, offering specific information, and more or less adapted to certain trading strategies. Thus, the best technical indicator is generally the one that is both the most suitable for the asset and the type of market targeted by the investor, and that provides the most reliable information.
An accessible and extremely popular technical indicator, the Simple Moving Average (SMA) informs the trader of the underlying trend followed by the price of an asset. It allows you to draw a curve following the evolution of the average price of an instrument over a predetermined period. As its sensitivity to price fluctuations varies over long or short periods, it’s a good idea to plot several moving averages. The crossings between the curves then indicate opportunities to take positions.
Generally considered even more useful than the Simple Moving Average, the Exponential Moving Average (EMA) provides a smoother curve of the average price of an asset. This is because its calculation formula weights the most recent prices more heavily and is therefore more sensitive to changes.
If your aim is to measure market volatility, Bollinger Bands are particularly effective. This indicator is made up of a central curve, corresponding to a moving average, and two side curves, whose spacing corresponds to twice the standard deviation over the N periods over which the moving average has been calculated. The distance between the two side curves, i.e. the size of the bands, directly and very simply informs the investor about the level of volatility of the market at any given time.
In addition, low volatility is usually followed by high volatility, and vice versa. This is because the bands move apart in strong trends and tighten in more neutral phases of market equilibrium. This provides the trader with entry opportunities.
Investors can also look for strong market trends, such as euphoric buying or excessive selling. If this is the case, the best technical indicator is undoubtedly the RSI (Relative Strength Index), which allows you to follow the speed and direction of a price movement. Indeed, this indicator can highlight the overbought or oversold phases of a financial instrument. Since the value of the RSI is always between 0 and 100, the curve's overshooting of the value 70 from below indicates a euphoric buying phase, while that of the value 30 from above indicates an oversold phase.
These specific phases usually predict impending trend reversals, and therefore represent interesting trading opportunities.
The best technical indicator is therefore not a single indicator, which would be the most suitable and reliable in any situation. On the contrary, the best indicator is situational, and corresponds both to the objectives of the trader, as well as to the market and the instruments in which they specialize.
