7 Technical Indicators to Build a Trading Toolkit

By  THE INVESTOPEDIA TEAM  Updated July 13, 2022

Reviewed by  CHARLES POTTERS

Technical indicators are used by traders to gain insight into the supply and demand of securities and market psychology.
Together, these indicators form the basis of technical analysis. Metrics, such as trading volume, provide clues as to
whether a price move will continue. In this way, indicators can be used to generate buy and sell signals. In this list, you'll
learn about seven technical indicators to add to your trading toolkit.

You don't need to use all of them, rather pick a few that you find helpful in making better trading decisions.

KEY TAKEAWAYS
Technical traders and chartists have a wide variety of indicators, patterns, and oscillators in their toolkit to
generate signals.
Some of these consider price history, others look at trading volume, and yet others are momentum indicators.
Often, these are used in tandem or combination with one another.
Here, we look at seven top tools market technicians employ, and that you should become familiar with if you plan
to trade based on technical analysis.

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$              2 years ago         

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Tools of the Trade

The tools of the trade for day traders and technical analysts consist of charting tools that generate signals to buy or sell,
or which indicate trends or patterns in the market. Broadly speaking, there are two basic types of technical indicators:

Overlays: Technical indicators that use the same scale as prices are plotted over the top of the prices on a stock chart.
Examples include moving averages and Bollinger Bands® or Fibonacci lines.
Oscillators: Rather than being overlaid on a price chart, technical indicators that oscillate between a local minimum and
maximum are plotted above or below a price chart. Examples include the stochastic oscillator, MACD, or RSI. It will
mainly be these second kind of technical indicators that we consider in this article.

Traders often use several different technical indicators in tandem when analyzing a security. With literally thousands of
different options, traders must choose the indicators that work best for them and familiarize themselves with how they
work. Traders may also combine technical indicators with more subjective forms of technical analysis, such as looking at
chart patterns, to come up with trade ideas. Technical indicators can also be incorporated into automated trading systems
given their quantitative nature.

1. On-Balance Volume
First up, use the on-balance volume indicator (OBV) to measure the positive and negative flow of volume in a security
over time.

The indicator is a running total of up volume minus down volume. Up volume is how much volume there is on a day when
the price rallied. Down volume is the volume on a day when the price falls. Each day volume is added or subtracted from
the indicator based on whether the price went higher or lower.

When OBV is rising, it shows that buyers are willing to step in and push the price higher. When OBV is falling, the selling
volume is outpacing buying volume, which indicates lower prices. In this way, it acts like a trend confirmation tool. If price
and OBV are rising, that helps indicate a continuation of the trend.

Traders who use OBV also watch for divergence. This occurs when the indicator and price are going in different
directions. If the price is rising but OBV is falling, that could indicate that the trend is not backed by strong buyers and
could soon reverse.
Image by Sabrina Jiang © Investopedia 2020

2. Accumulation/Distribution Line
One of the most commonly used indicators to determine the money flow in and out of a security is
the accumulation/distribution line (A/D line).

It is similar to the on-balance volume indicator (OBV), but instead of considering only the closing price of the security for
the period, it also takes into account the trading range for the period and where the close is in relation to that range. If a
stock finishes near its high, the indicator gives volume more weight than if it closes near the midpoint of its range. The
different calculations mean that OBV will work better in some cases and A/D will work better in others.

If the indicator line is trending up, it shows buying interest, since the stock is closing above the halfway point of the range.
This helps confirm an uptrend. On the other hand, if A/D is falling, that means the price is finishing in the lower portion of
its daily range, and thus volume is considered negative. This helps confirm a downtrend. 

Traders using the A/D line also watch for divergence. If the A/D starts falling while the price is rising, this signals that the
trend is in trouble and could reverse. Similarly, if the price is trending lower and A/D starts rising, that could signal higher
prices to come.

Image by Sabrina Jiang © Investopedia 2020

3. Average Directional Index
The average directional index (ADX) is a trend indicator used to measure the strength and momentum of a trend. When
the ADX is above 40, the trend is considered to have a lot of directional strength, either up or down, depending on the
direction the price is moving.

When the ADX indicator is below 20, the trend is considered to be weak or non-trending.

The ADX is the main line on the indicator, usually colored black. There are two additional lines that can be optionally
shown. These are DI+ and DI-. These lines are often colored red and green, respectively. All three lines work together to
show the direction of the trend as well as the momentum of the trend.

ADX above 20 and DI+ above DI-: That's an uptrend.

ADX above 20 and DI- above DI+: That's a downtrend.
ADX below 20 is a weak trend or ranging period, often associated with the DI- and DI+ rapidly crisscrossing each
other.

Image by Sabrina Jiang © Investopedia 2020

4. Aroon Indicator
The Aroon oscillator is a technical indicator used to measure whether a security is in a trend, and more specifically if the
price is hitting new highs or lows over the calculation period (typically 25).

The indicator can also be used to identify when a new trend is set to begin. The Aroon indicator comprises two lines: an
Aroon Up line and an Aroon Down line.

When the Aroon Up crosses above the Aroon Down, that is the first sign of a possible trend change. If the Aroon Up hits
100 and stays relatively close to that level while the Aroon Down stays near zero, that is positive confirmation of an
uptrend.

The reverse is also true. If Aroon Down crosses above Aroon Up and stays near 100, this indicates that the downtrend is
in force.
Image by Sabrina Jiang © Investopedia 2020

5. MACD
The moving average convergence divergence (MACD) indicator helps traders see the trend direction, as well as the
momentum of that trend. It also provides a number of trade signals.

When the MACD is above zero, the price is in an upward phase. If the MACD is below zero, it has entered
a bearish period.

The indicator is composed of two lines: the MACD line and a signal line, which moves slower. When MACD crosses below
the signal line, it indicates that the price is falling. When the MACD line crosses above the signal line, the price is rising. 

Looking at which side of zero the indicator is on aids in determining which signals to follow. For example, if the indicator is
above zero, watch for the MACD to cross above the signal line to buy. If the MACD is below zero, the MACD crossing
below the signal line may provide the signal for a possible short trade.

Image by Sabrina Jiang © Investopedia 2020

6. Relative Strength Index

The relative strength index (RSI) has at least three major uses. The indicator moves between zero and 100, plotting
recent price gains versus recent price losses. The RSI levels therefore help in gauging momentum and trend strength. 
The most basic use of an RSI is as an overbought and oversold indicator. When RSI moves above 70, the asset is
considered overbought and could decline. When the RSI is below 30, the asset is oversold and could rally. However,
making this assumption is dangerous; therefore, some traders wait for the indicator to rise above 70 and then drop below
before selling, or drop below 30 and then rise back above before buying. 

Divergence is another use of the RSI. When the indicator is moving in a different direction than the price, it shows that the
current price trend is weakening and could soon reverse.

A third use for the RSI is support and resistance levels. During uptrends, a stock will often hold above the 30 level and
frequently reach 70 or above. When a stock is in a downtrend, the RSI will typically hold below 70 and frequently reach 30
or below.

Image by Sabrina Jiang © Investopedia 2020

7. Stochastic Oscillator
The stochastic oscillator is an indicator that measures the current price relative to the price range over a number of
periods. Plotted between zero and 100, the idea is that, when the trend is up, the price should be making new highs. In a
downtrend, the price tends to make new lows. The stochastic tracks whether this is happening.

The stochastic moves up and down relatively quickly as it is rare for the price to make continual highs, keeping the
stochastic near 100, or continual lows, keeping the stochastic near zero. Therefore, the stochastic is often used as an
overbought and oversold indicator. Values above 80 are considered overbought, while levels below 20 are considered
oversold.

Consider the overall price trend when using overbought and oversold levels. For example, during an uptrend, when the
indicator drops below 20 and rises back above it, that is a possible buy signal. But rallies above 80 are less consequential
because we expect to see the indicator to move to 80 and above regularly during an uptrend. During a downtrend, look for
the indicator to move above 80 and then drop back below to signal a possible short trade. The 20 level is less significant
in a downtrend.
Image by Sabrina Jiang © Investopedia 2020

Is Technical Analysis Reliable?

Technical analysis is the reading of market sentiment via the use of graph patterns and signals. Various empirical studies
have pointed to its effectiveness, but the range of success is varied and its accuracy remains undecided. It is best to use
a suite of technical tools and indicators in tandem with other techniques like fundamental analysis to improve reliability.

Which Technical Indicator Can Best Spot Overbought/Oversold Conditions?

The relative strength index (RSI) is among the most popular technical indicators for identifying overbought or oversold
stocks. The RSI is bound between 0 and 100. Traditionally, a reading above 70 indicates overbought ad below 30
oversold.

How Many Technical Analysis Tools Are There?

There are several dozen technical analysis tools, including a range of indicators and chart patterns. Market technicians
are always creating new tools and refining old ones.

The Bottom Line

The goal of every short-term trader is to determine the direction of a given asset's momentum and to attempt to profit from
it. There have been hundreds of technical indicators and oscillators developed for this specific purpose, and this article
has provided a handful that you can start trying out. Use the indicators to develop new strategies or consider incorporating
them into your current strategies. To determine which ones to use, try them out in a demo account. Pick the ones you like
the most, and leave the rest.
On-Balance Volume (OBV): Definition,
Formula, and Uses as Indicator
By  ADAM HAYES  Updated July 08, 2022
Reviewed by  SOMER ANDERSON
Fact checked by  PETE RATHBURN

What Is On-Balance Volume (OBV)?

On-balance volume (OBV) is a technical trading momentum indicator that
uses volume flow to predict changes in stock price. Joseph Granville first developed the
OBV metric in the 1963 book Granville's New Key to Stock Market Profits. 1 

Granville believed that volume was the key force behind markets and designed OBV to
project when major moves in the markets would occur based on volume changes. In
his book, he described the predictions generated by OBV as "a spring being wound
tightly." He believed that when volume increases sharply without a significant change in
the stock's price, the price will eventually jump upward or fall downward.

Image by Sabrina Jiang © Investopedia 2021

KEY TAKEAWAYS
On-balance volume (OBV) is a technical indicator of momentum, using volume
changes to make price predictions.
OBV shows crowd sentiment that can predict a bullish or bearish outcome.
 Comparing relative action between price bars and OBV generates more
actionable signals than the green or red volume histograms commonly found at
the bottom of price charts. 

The Formula for OBV Is

⎪volume,
⎧ if close > closeprev ​

OBV = OBVprev ​ + ⎨0,

​ ​ if close = closeprev ​ ​

⎪
⎩
−volume, if close < closeprev ​

where:
OBV = Current on-balance volume level
OBVprev = Previous on-balance volume level
​

volume = Latest trading volume amount

Calculating OBV
On-balance volume provides a running total of an asset's trading volume and indicates
whether this volume is flowing in or out of a given security or currency pair. The OBV is
a cumulative total of volume (positive and negative). There are three rules implemented
when calculating the OBV. They are:

1. If today's closing price is higher than yesterday's closing price, then: Current OBV =
Previous OBV + today's volume

2. If today's closing price is lower than yesterday's closing price, then: Current OBV =
Previous OBV - today's volume

3. If today's closing price equals yesterday's closing price, then: Current OBV =
Previous OBV

What Does On-Balance Volume Tell You?

The theory behind OBV is based on the distinction between smart money –
namely, institutional investors – and less sophisticated retail investors. As mutual
funds and pension funds begin to buy into an issue that retail investors are selling,
volume may increase even as the price remains relatively level. Eventually, volume
drives the price upward. At that point, larger investors begin to sell, and smaller
investors begin buying.

Despite being plotted on a price chart and measured numerically, the actual individual
quantitative value of OBV is not relevant. The indicator itself is cumulative, while the
time interval remains fixed by a dedicated starting point, meaning the real number
value of OBV arbitrarily depends on the start date. Instead, traders and analysts look to
the nature of OBV movements over time; the slope of the OBV line carries all of the
weight of analysis.

Analysts look to volume numbers on the OBV to track large, institutional investors.

They treat divergences between volume and price as a synonym of the relationship
between "smart money" and the disparate masses, hoping to showcase opportunities
for buying against incorrect prevailing trends. For example, institutional money may
drive up the price of an asset, then sell after other investors jump on the bandwagon.

Example of How to Use On-Balance Volume

Below is a list of 10 days' worth of a hypothetical stock's closing price and volume:

Day one: closing price equals $10, volume equals 25,200 shares
Day two: closing price equals $10.15, volume equals 30,000 shares
Day three: closing price equals $10.17, volume equals 25,600 shares
Day four: closing price equals $10.13, volume equals 32,000 shares
Day five: closing price equals $10.11, volume equals 23,000 shares
Day six: closing price equals $10.15, volume equals 40,000 shares
Day seven: closing price equals $10.20, volume equals 36,000 shares
Day eight: closing price equals $10.20, volume equals 20,500 shares
Day nine: closing price equals $10.22, volume equals 23,000 shares
Day 10: closing price equals $10.21, volume equals 27,500 shares

As can be seen, days two, three, six, seven and nine are up days, so these trading
volumes are added to the OBV. Days four, five and 10 are down days, so these trading
volumes are subtracted from the OBV. On day eight, no changes are made to the OBV
since the closing price did not change. Given the days, the OBV for each of the 10 days
is:

Day one OBV = 0

Day two OBV = 0 + 30,000 = 30,000
Day three OBV = 30,000 + 25,600 = 55,600
Day four OBV = 55,600 - 32,000 = 23,600
Day five OBV = 23,600 - 23,000 = 600
Day six OBV = 600 + 40,000 = 40,600
Day seven OBV = 40,600 + 36,000 = 76,600
Day eight OBV = 76,600
Day nine OBV = 76,600 + 23,000 = 99,600
Day 10 OBV = 99,600 - 27,500 = 72,100

The Difference Between OBV and Accumulation/Distribution

On-balance volume and the accumulation/distribution line are similar in that they are
both momentum indicators that use volume to predict the movement of “smart money”.
However, this is where the similarities end. In the case of on-balance volume, it is
calculated by summing the volume on an up-day and subtracting the volume on a
down-day.

The formula used to create the accumulation/distribution (Acc/Dist) line is quite different
than the OBV shown above. The formula for the Acc/Dist, without getting too
complicated, is that it uses the position of the current price relative to its recent trading
range and multiplies it by that period's volume.

Limitations of OBV
One limitation of OBV is that it is a leading indicator, meaning that it may produce
predictions, but there is little it can say about what has actually happened in terms of
the signals it produces. Because of this, it is prone to produce false signals. It can
therefore be balanced by lagging indicators. Add a moving average line to the OBV to
look for OBV line breakouts; you can confirm a breakout in the price if the OBV
indicator makes a concurrent breakout.

Another note of caution in using the OBV is that a large spike in volume on a single day
can throw off the indicator for quite a while. For instance, a surprise earnings
announcement, being added or removed from an index, or massive institutional block
trades can cause the indicator to spike or plummet, but the spike in volume may not be
indicative of a trend.
Accumulation/Distribution Indicator (A/D)
By  CORY MITCHELL  Updated May 18, 2022
Reviewed by  CHARLES POTTERS
Fact checked by  SUZANNE KVILHAUG

What Is the Accumulation/Distribution Indicator (A/D)?

The accumulation/distribution indicator (A/D) is a cumulative indicator that uses volume and
price to assess whether a stock is being accumulated or distributed. The A/D measure
seeks to identify divergences between the stock price and the volume flow. This provides
insight into how strong a trend is. If the price is rising but the indicator is falling, then it
suggests that buying or accumulation volume may not be enough to support the price rise
and a price decline could be forthcoming.

KEY TAKEWAYS
The accumulation/distribution (A/D) line gauges supply and demand of an asset or
security by looking at where the price closed within the period’s range and then
multiplying that by volume.
The A/D indicator is cumulative, meaning one period’s value is added or subtracted
from the last.
In general, a rising A/D line helps confirm a rising price trend, while a falling A/D line
helps confirm a price downtrend.

The Accumulation/Distribution Indicator (A/D) Formula

(Close − Low) − (High − Close)
MFM =
High − Low
​

where:
MFM = Money Flow Multiplier
Close = Closing price
Low = Low price for the period
High = High price for the period

Money Flow Volume = MFM × Period Volume

A/D = Previous A/D + CMFV

where:
CMFV = Current period money flow volume
How to Calculate the A/D Line

Start by calculating the multiplier. Note the most recent period’s close, high, and low to
calculate.
Use the multiplier and the current period’s volume to calculate the money flow volume.
Add the money flow volume to the last A/D value. For the first calculation, use money flow
volume as the first value.
Repeat the process as each period ends, adding/subtracting the new money flow volume
to/from the prior total. This is A/D.

What Does the Accumulation/Distribution Indicator (A/D) Tell You?

The A/D line helps to show how supply and demand factors are influencing price. A/D can
move in the same direction as price changes or in the opposite direction.

The multiplier in the calculation provides a gauge for how strong the buying or selling was
during a particular period. It does this by determining whether the price closed in the upper
or lower portion of its range. This is then multiplied by the volume. Therefore, when a stock
closes near the high of the period’s range and has high volume, it will result in a large A/D
jump. Alternatively, if the price finishes near the high of the range but volume is low, or if the
volume is high but the price finishes more toward the middle of the range, then the A/D will
not move up as much.

The same concepts apply when the price closes in the lower portion of the period’s price
range. Both volume and where the price closes within the period’s range determine how
much the A/D will decline.

Image by Sabrina Jiang © Investopedia 2021

The A/D line is used to help assess price trends and potentially spot forthcoming reversals.
If a security’s price is in a downtrend while the A/D line is in an uptrend, then the indicator
shows there may be buying pressure and the security’s price may reverse to the upside.
Conversely, if a security’s price is in an uptrend while the A/D line is in a downtrend, then the
indicator shows there may be selling pressure, or higher distribution. This warns that the
price may be due for a decline.

In both cases, the steepness of the A/D line provides insight into the trend. 1  A strongly
rising A/D line confirms a strongly rising price. Similarly, if the price is falling and the A/D is
also falling, then there is still plenty of distribution and prices are likely to continue to decline.

The Accumulation/Distribution Indicator (A/D) vs. On-Balance Volume

(OBV)
Both of these technical indicators use price and volume, albeit somewhat differently. On-
balance volume (OBV) looks at whether the current closing price is higher or lower than the
prior close. If the close is higher, then the period’s volume is added. If the close is lower,
then the period’s volume is subtracted.

The A/D indicator doesn’t factor in the prior close and uses a multiplier based on where the
price closed within the period’s range. Therefore, the indicators use different calculations
and may provide different information.

Limitations of Using the Accumulation/Distribution Indicator (A/D)

The A/D indicator does not factor in price changes from one period to the next, and focuses
only on where the price closes within the current period’s range. This creates some
anomalies.

Assume a stock gaps down 20% on huge volume. The price oscillates throughout the day
and finishes in the upper portion of its daily range, but is still down 18% from the prior close.
Such a move would actually cause the A/D to rise. Even though the stock lost a significant
amount of value, it finished in the upper portion of its daily range; therefore, the indicator will
increase, likely dramatically, due to the large volume. Traders need to monitor the price
chart and mark any potential anomalies like these, as they could affect how the indicator is
interpreted.

Also, one of the main uses of the indicator is to monitor for divergences. Divergences can
last a long time and are poor timing signals. When divergence appears between the
indicator and price, it doesn’t mean a reversal is imminent. It may take a long time for the
price to reverse, or it may not reverse at all.

The A/D is just one tool that can be used to assess strength or weakness within a trend, but
it is not without its faults. Use the A/D indicator in conjunction with other forms of analysis,
such as price action analysis, chart patterns, or fundamental analysis, to get a more
complete picture of what is moving the price of a stock.
Average Directional Index (ADX)
By  CORY MITCHELL  Updated August 18, 2021
Reviewed by  GORDON SCOTT

What Is the Average Directional Index (ADX)?

The average directional index (ADX) is a technical analysis indicator used by some
traders to determine the strength of a trend.

The trend can be either up or down, and this is shown by two accompanying indicators,
the negative directional indicator (-DI) and the positive directional indicator (+DI).
Therefore, the ADX commonly includes three separate lines. These are used to help
assess whether a trade should be taken long or short, or if a trade should be taken at
all.

KEY TAKEAWAYS
Designed by Welles Wilder for commodity daily charts, the ADX is now used in
several markets by technical traders to judge the strength of a trend.
The ADX makes use of a positive (+DI) and negative (-DI) directional indicator
in addition to the trendline.
The trend has strength when ADX is above 25; the trend is weak or the price is
trendless when ADX is below 20, according to Wilder.
Non-trending doesn't mean the price isn't moving. It may not be, but the price
could also be making a trend change or is too volatile for a clear direction to be
present.

The Average Directional Index (ADX) Formulae

The ADX requires a sequence of calculations due to the multiple lines in the indicator.
 Smoothed +DM
+DI = ( ) × 100
ATR 
​

Smoothed -DM
-DI = ( ) × 100
ATR 
​

∣ +DI − -DI ∣
DX = ( ) × 100
∣ +DI + -DI ∣
​

(Prior ADX × 13) + Current ADX

ADX =
14
​

where:
+DM (Directional Movement) = Current High − PH
PH = Previous High
-DM = Previous Low − Current Low
14 ∑14
t=1 DM
Smoothed +/-DM = ∑t=1 DM − ( ) + CDM
​

14 ​

CDM = Current DM
ATR = Average True Range

Calculating the Average Directional Movement Index (ADX)

Calculate +DM, -DM, and the true range (TR) for each period. Fourteen periods are
typically used.
+DM = current high - previous high.
-DM = previous low - current low.
Use +DM when current high - previous high > previous low - current low. Use -DM
when previous low - current low > current high - previous high.
TR is the greater of the current high - current low, current high - previous close, or
current low - previous close.
Smooth the 14-period averages of +DM, -DM, and TR—the TR formula is below. Insert
the -DM and +DM values to calculate the smoothed averages of those.
First 14TR = sum of first 14 TR readings.
Next 14TR value = first 14TR - (prior 14TR/14) + current TR.
Next, divide the smoothed +DM value by the smoothed TR value to get +DI. Multiply by
100.
Divide the smoothed -DM value by the smoothed TR value to get -DI. Multiply by 100.
The directional movement index (DMI) is +DI minus -DI, divided by the sum of +DI and
-DI (all absolute values). Multiply by 100.
To get the ADX, continue to calculate DX values for at least 14 periods. Then, smooth
the results to get ADX.
First ADX = sum 14 periods of DX / 14.
After that, ADX = ((prior ADX * 13) + current DX) / 14.
What Does the Average Directional Index (ADX) Tell You?
The ADX, negative directional indicator (-DI), and positive directional indicator (+DI)
are momentum indicators. The ADX helps investors determine trend strength, while -DI
and +DI help determine trend direction.

The ADX identifies a strong trend when the ADX is over 25 and a weak trend when the
ADX is below 20. Crossovers of the -DI and +DI lines can be used to generate trade
signals. For example, if the +DI line crosses above the -DI line and the ADX is above
20, or ideally above 25, then that is a potential signal to buy. On the other hand, if the -
DI crosses above the +DI, and the ADX is above 20 or 25, then that is an opportunity to
enter a potential short trade.

Crosses can also be used to exit current trades. For example, if long, exit when the -DI
crosses above the +DI. Meanwhile, when the ADX is below 20 the indicator is signaling
that the price is trendless and that it might not be an ideal time to enter a trade.

Image by Sabrina Jiang © Investopedia 2021

The Average Directional Index (ADX) vs. The Aroon Indicator

The ADX indicator is composed of a total of three lines, while the Aroon indicator is
composed of two.

The two indicators are similar in that they both have lines representing positive and
negative movement, which helps to identify trend direction. The Aroon reading/level
also helps determine trend strength, as the ADX does. The calculations are different
though, so crossovers on each of the indicators will occur at different times.
Limitations of Using the Average Directional Index (ADX)
Crossovers can occur frequently, sometimes too frequently, resulting in confusion and
potentially lost money on trades that quickly go the other way. These are called false
signals and are more common when ADX values are below 25. That said, sometimes
the ADX reaches above 25, but is only there temporarily and then reverses along with
the price.

Like any indicator, the ADX should be combined with price analysis and potentially
other indicators to help filter signals and control risk.
Aroon Oscillator
By  CORY MITCHELL  Updated June 08, 2022
Reviewed by  THOMAS J. CATALANO
Fact checked by  KIRSTEN ROHRS SCHMITT

What Is the Aroon Oscillator?

The Aroon Oscillator is a trend-following indicator that uses aspects of the Aroon
Indicator (Aroon Up and Aroon Down) to gauge the strength of a current trend and the
likelihood that it will continue.

KEY TAKEAWAYS
The Aroon Oscillator uses Aroon Up and Aroon Down to create the oscillator.
Aroon Up and Aroon Down measure the number of periods since the last 25-
period high and low.
The Aroon Oscillator crosses above the zero line when Aroon Up moves above
Aroon Down. The oscillator drops below the zero line when the Aroon Down
moves below the Aroon Up.

TradingView.

Understanding the Aroon Oscillator

Aroon oscillator readings above zero indicate that an uptrend is present, while readings
below zero indicate that a downtrend is present. Traders watch for zero line crossovers
to signal potential trend changes. They also watch for big moves, above 50 or below
-50 to signal strong price moves.

The Aroon Oscillator was developed by Tushar Chande in 1995 as part of the Aroon
Indicator system. Chande’s intention for the system was to highlight short-term trend
changes. The name Aroon is derived from the Sanskrit language and roughly translates
to “dawn’s early light.”

The Aroon Indicator system includes Aroon Up, Aroon Down, and Aroon Oscillator. The
Aroon Up and Aroon Down lines must be calculated first before drawing the Aroon
Oscillator. This indicator typically uses a timeframe of 25 periods, however, the
timeframe is subjective. Using more periods garners fewer waves and a smoother-
looking indicator. Using fewer periods generates more waves and a quicker turnaround
in the indicator. The oscillator moves between -100 and 100. A high oscillator value is
an indication of an uptrend while a low oscillator value is an indication of a downtrend.

Aroon Up and Aroon Down move between zero and 100. On a scale of zero to 100, the
higher the indicator’s value, the stronger the trend. For example, a price reaching new
highs one day ago would have an Aroon Up value of 96 ((25-1)/25)x100). Similarly, a
price reaching new lows one day ago would have an Aroon Down value of 96 ((25-
1)x100).

The highs and lows used in the Aroon Up and Aroon Down calculations help to create
an inverse relationship between the two indicators. When the Aroon Up value
increases, the Aroon Down value will typically see a decrease and vice versa.

When Aroon Up remains high from consecutive new highs, the oscillator value will be
high, following the uptrend. When a security’s price is on a downtrend with many new
lows, the Aroon Down value will be higher resulting in a lower oscillator value.

The Aroon Oscillator line can be included with or without the Aroon Up and Aroon
Down when viewing a chart. Significant changes in the direction of the Aroon Oscillator
can help to identify a new trend.

Aroon Oscillator Formula and Calculation

The formula for the Aroon oscillator is:

Aroon Oscillator = Aroon Up − Aroon Down

(25 − Periods Since 25-Period High)
Aroon Up = 100 ∗
25
​

(25 − Periods Since 25-Period Low)
Aroon Down = 100 ∗
25
​

To calculate the Aroon oscillator:

Calculate Aroon Up by finding how many periods it has been since the last 25-period
high. Subtract this from 25, then divide the result by 25. Multiply by 100.
Calculate Aroon Down by finding how many periods it has been since the last 25-period
low. Subtract this from 25, then divide the result by 25. Multiply by 100.
Subtract Aroon Down from Aroon Up to get the Aroon Oscillator value.
Repeat the steps as each time period ends.

Aroon oscillator differs from the rate of change (ROC) indicator in that the former is
tracking whether a 25-period high or low occurred more recently while the latter tracks
the momentum by looking at highs and lows and how far the current price has moved
relative to a price in the past.

Aroon Oscillator Trade Signals

The Aroon Oscillator can generate trade signals or provide insight into the current trend
direction of an asset.

When the oscillator moves above the zero line, the Aroon Up is crossing above the
Aroon Down and the price has made a high more recently than a low, a sign that an
uptrend is beginning.

When the oscillator moves below zero, the Aroon Down is crossing below the Aroon
Up. A low occurred more recently than a high, which could signal that a downtrend is
starting.

Limitations of Using the Aroon Oscillator

The Aroon Oscillator keeps a trader in a trade when a long-term trend develops. During
an uptrend, for example, the price tends to keep achieving new highs which keep the
oscillator above zero.

During choppy market conditions, the indicator will provide poor trade signals, as the
price and the oscillator whipsaw back and forth.

The indicator may provide trade signals too late to be useful. The price may have
already run a significant course before a trade signal develops. The price may be due
for a retracement when the trade signal is appearing.

The number of periods is also arbitrary and there is no validity that a more recent high
or low within the last 25-periods will guarantee a new and sustained uptrend or
downtrend.

The indicator is best used in conjunction with price action analysis fundamentals of

long-term trading, and other technical indicators.
MACD Indicator Explained With Formula,
Examples, and Limitations
By  JASON FERNANDO  Updated March 01, 2022
Reviewed by  SAMANTHA SILBERSTEIN
Fact checked by  KATRINA MUNICHIELLO

Investopedia / Xiaojie Liu

What Is Moving Average Convergence Divergence (MACD)?

Moving average convergence divergence (MACD) is a trend-following momentum indicator
that shows the relationship between two moving averages of a security’s price. The MACD
is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-
period EMA.

The result of that calculation is the MACD line. A nine-day EMA of the MACD called the
"signal line," is then plotted on top of the MACD line, which can function as a trigger for buy
and sell signals. Traders may buy the security when the MACD crosses above its signal line
and sell—or short—the security when the MACD crosses below the signal line. Moving
average convergence divergence (MACD) indicators can be interpreted in several ways, but
the more common methods are crossovers, divergences, and rapid rises/falls.

KEY TAKEAWAYS
Moving average convergence divergence (MACD) is calculated by subtracting the
26-period exponential moving average (EMA) from the 12-period EMA.
MACD triggers technical signals when it crosses above (to buy) or below (to sell) its
signal line.
The speed of crossovers is also taken as a signal of a market is overbought or
oversold.
MACD helps investors understand whether the bullish or bearish movement in the
price is strengthening or weakening.

MACD Formula
MACD = 12-Period EMA  −  26-Period EMA

MACD is calculated by subtracting the long-term EMA (26 periods) from the short-term EMA
(12 periods). An exponential moving average (EMA) is a type of moving average (MA) that
places a greater weight and significance on the most recent data points.

The exponential moving average is also referred to as the exponentially weighted moving

average. An exponentially weighted moving average reacts more significantly to recent price
changes than a simple moving average (SMA), which applies an equal weight to all
observations in the period.

Learning From MACD

The MACD has a positive value (shown as the blue line in the lower chart) whenever the 12-
period EMA (indicated by the red line on the price chart) is above the 26-period EMA (the
blue line in the price chart) and a negative value when the 12-period EMA is below the 26-
period EMA. The more distant the MACD is above or below its baseline indicates that the
distance between the two EMAs is growing.

In the following chart, you can see how the two EMAs applied to the price chart correspond
to the MACD (blue) crossing above or below its baseline (dashed) in the indicator below the
price chart.

Image by Sabrina Jiang © Investopedia 2020 

MACD is often displayed with a histogram (see the chart below) which graphs the distance
between the MACD and its signal line. If the MACD is above the signal line, the histogram
will be above the MACD’s baseline. If the MACD is below its signal line, the histogram will
be below the MACD’s baseline. Traders use the MACD’s histogram to identify when bullish
or bearish momentum is high.
Image by Sabrina Jiang © Investopedia 2020

MACD vs. Relative Strength

The relative strength indicator (RSI) aims to signal whether a market is considered to
be overbought or oversold in relation to recent price levels. The RSI is an oscillator that
calculates average price gains and losses over a given period of time. The default time
period is 14 periods with values bounded from 0 to 100.

MACD measures the relationship between two EMAs, while the RSI measures price change
in relation to recent price highs and lows. These two indicators are often used together to
provide analysts a more complete technical picture of a market.

These indicators both measure momentum in a market, but, because they measure different
factors, they sometimes give contrary indications. For example, the RSI may show a reading
above 70 for a sustained period of time, indicating a market is overextended to the buy-side
in relation to recent prices, while the MACD indicates the market is still increasing in buying
momentum. Either indicator may signal an upcoming trend change by showing divergence
from price (price continues higher while the indicator turns lower, or vice versa).

Limitations of MACD
One of the main problems with divergence is that it can often signal a possible reversal but
then no actual reversal actually happens—it produces a false positive. The other problem is
that divergence doesn't forecast all reversals. In other words, it predicts too many reversals
that don't occur and not enough real price reversals.

"False positive" divergence often occurs when the price of an asset moves sideways, such
as in a range or triangle pattern following a trend. A slowdown in the momentum—sideways
movement or slow trending movement—of the price will cause the MACD to pull away from
its prior extremes and gravitate toward the zero lines even in the absence of a true reversal.
Example of MACD Crossovers
As shown on the following chart, when the MACD falls below the signal line, it is a bearish
signal that indicates that it may be time to sell. Conversely, when the MACD rises above the
signal line, the indicator gives a bullish signal, which suggests that the price of the asset is
likely to experience upward momentum. Some traders wait for a confirmed cross above the
signal line before entering a position to reduce the chances of being "faked out" and
entering a position too early.

Crossovers are more reliable when they conform to the prevailing trend. If the MACD
crosses above its signal line following a brief correction within a longer-term uptrend, it
qualifies as bullish confirmation.

Image by Sabrina Jiang © Investopedia 2020

If the MACD crosses below its signal line following a brief move higher within a longer-term
downtrend, traders would consider that a bearish confirmation.
Image by Sabrina Jiang © Investopedia 2020

Example of Divergence
When the MACD forms highs or lows that diverge from the corresponding highs and lows on
the price, it is called a divergence. A bullish divergence appears when the MACD forms two
rising lows that correspond with two falling lows on the price. This is a valid bullish signal
when the long-term trend is still positive.

Some traders will look for bullish divergences even when the long-term trend is negative
because they can signal a change in the trend, although this technique is less reliable.

Image by Sabrina Jiang © Investopedia 2020

When the MACD forms a series of two falling highs that correspond with two rising highs on
the price, a bearish divergence has been formed. A bearish divergence that appears during
a long-term bearish trend is considered confirmation that the trend is likely to continue.

Some traders will watch for bearish divergences during long-term bullish trends because
they can signal weakness in the trend. However, it is not as reliable as a bearish divergence
during a bearish trend.

Image by Sabrina Jiang © Investopedia 2020

Example of Rapid Rises or Falls

When the MACD rises or falls rapidly (the shorter-term moving average pulls away from the
longer-term moving average), it is a signal that the security is overbought or oversold and
will soon return to normal levels. Traders will often combine this analysis with the relative
strength index (RSI) or other technical indicators to verify overbought or oversold conditions.
Image by Sabrina Jiang © Investopedia 2020

It is not uncommon for investors to use the MACD’s histogram the same way they may use
the MACD itself. Positive or negative crossovers, divergences, and rapid rises or falls can
be identified on the histogram as well. Some experience is needed before deciding which is
best in any given situation because there are timing differences between signals on the
MACD and its histogram.

How Do Traders Use Moving Average Convergence Divergence (MACD)?

Traders use MACD to identify changes in the direction or severity of a stock’s price trend.
MACD can seem complicated at first glance, since it relies on additional statistical concepts
such as the exponential moving average (EMA). But fundamentally, MACD helps traders
detect when the recent momentum in a stock’s price may signal a change in its underlying
trend. This can help traders decide when to enter, add to, or exit a position.

Is MACD a Leading Indicator, or a Lagging Indicator?

MACD is a lagging indicator. After all, all of the data used in MACD is based on the historical
price action of the stock. Since it is based on historical data, it must necessarily “lag” the
price. However, some traders use MACD histograms to predict when a change in trend will
occur. For these traders, this aspect of the MACD might be viewed as a leading indicator of
future trend changes.

What Is a MACD Positive Divergence?

A MACD positive divergence is a situation in which the MACD does not reach a new low,
despite the fact that the price of the stock reached a new low. This is seen as a bullish
trading signal—hence, the term “positive divergence.” If the opposite scenario occurs—the
stock price reaching a new high, but the MACD failing to do so—this would be seen as a
bearish indicator and referred to as a negative divergence.
Relative Strength Index (RSI) Indicator
Explained With Formula
By  JASON FERNANDO  Updated July 15, 2022
Reviewed by  CHARLES POTTERS
Fact checked by  TIMOTHY LI

Investopedia / Julie Bang

What Is the Relative Strength Index (RSI)?

The relative strength index (RSI) is a momentum indicator used in technical analysis.
RSI measures the speed and magnitude of a security's recent price changes to
evaluate overvalued or undervalued conditions in the price of that security.

The RSI is displayed as an oscillator (a line graph) on a scale of zero to 100. The
indicator was developed by J. Welles Wilder Jr. and introduced in his seminal 1978
book, New Concepts in Technical Trading Systems. 1

The RSI can do more than point to overbought and oversold securities. It can also
indicate securities that may be primed for a trend reversal or corrective pullback in
price. It can signal when to buy and sell. Traditionally, an RSI reading of 70 or above
indicates an overbought situation. A reading of 30 or below indicates an oversold
condition.

KEY TAKEAWAYS
The relative strength index (RSI) is a popular momentum oscillator introduced
in 1978.
The RSI provides technical traders with signals about bullish and bearish price
momentum, and it is often plotted beneath the graph of an asset’s price.
An asset is usually considered overbought when the RSI is above 70 and
oversold when it is below 30.
The RSI line crossing below the overbought line or above oversold line is often
seen by traders as a signal to buy or sell.
The RSI works best in trading ranges rather than trending markets.

How the Relative Strength Index (RSI) Works

As a momentum indicator, the relative strength index compares a security's strength on
days when prices go up to its strength on days when prices go down. Relating the
result of this comparison to price action can give traders an idea of how a security may
perform. The RSI, used in conjunction with other technical indicators, can help traders
make better-informed trading decisions.

Calculating RSI
The RSI uses a two-part calculation that starts with the following formula:

100
RSIstep one = 100 − [ 1+ Average gain
​ ] ​

Average loss ​

The average gain or loss used in this calculation is the average percentage gain or loss
during a look-back period. The formula uses a positive value for the average loss.
Periods with price losses are counted as zero in the calculations of average gain.
Periods with price increases are counted as zero in the calculations of average loss.

The standard number of periods used to calculate the initial RSI value is 14. For
example, imagine the market closed higher seven out of the past 14 days with an
average gain of 1%. The remaining seven days all closed lower with an average loss of
−0.8%.

The first calculation for the RSI would look like the following expanded calculation:

⎡ ⎤
55.55 = 100 − ⎢ 1001% ⎥
( 14 )
​ ​ ​

⎣ 1+ 0.8% ⎦
​

( 14 )
​

Once there are 14 periods of data available, the second calculation can be done. Its
purpose is to smooth the results so that the RSI only nears 100 or zero in a
strongly trending market.

100
RSIstep two = 100 − [ (Previous Average Gain×13) + Current Gain ]
1+
​ ​

((Previous Average Loss×13) + Current Loss) ​

Plotting RSI
After the RSI is calculated, the RSI indicator can be plotted beneath an asset’s price
chart, as shown below. The RSI will rise as the number and size of up days increase. It
will fall as the number and size of down days increase.
Image by Sabrina Jiang © Investopedia 2021

As you can see in the above chart, the RSI indicator can stay in the overbought region
for extended periods while the stock is in an uptrend. The indicator may also remain in
oversold territory for a long time when the stock is in a downtrend. This can be
confusing for new analysts, but learning to use the indicator within the context of the
prevailing trend will clarify these issues.

Practice trading with virtual money

SELECT A STOCK

TSLA AAPL NKE AMZN WMT

TESLA … APPLE … NIKE INC AMAZO… WALM…

SELECT INVESTMENT AMOUNT SELECT A PURCHASE DATE

$              2 years ago         
  CALCULATE

Why Is RSI Important?

Traders can use RSI to predict the price behavior of a security.
It can help traders validate trends and trend reversals.
It can point to overbought and oversold securities.
It can provide short-term traders with buy and sell signals.
It's a technical indicator that can be used with others to support trading strategies.

Using RSI With Trends

Modify RSI Levels to Fit Trends
The primary trend of the security is important to know to properly understand RSI
readings. For example, well-known market technician Constance Brown, CMT,
proposed that an oversold reading by the RSI in an uptrend is probably much higher
than 30. Likewise, an overbought reading during a downtrend is much lower than 70. 2

As you can see in the following chart, during a downtrend, the RSI peaks near 50
rather than 70. This could be seen by traders as more reliably signaling bearish
conditions.

Many investors create a horizontal trendline between the levels of 30 and 70 when a

strong trend is in place to better identify the overall trend and extremes.

On the other hand, modifying overbought or oversold RSI levels when the price of a
stock or asset is in a long-term horizontal channel or trading range (rather than a strong
upward or downward trend) is usually unnecessary.

The relative strength indicator is not as reliable in trending markets as it is in trading

ranges. In fact, most traders understand that the signals given by the RSI in strong
upward or downward trends often can be false.

Use Buy and Sell Signals That Fit Trends

A related concept focuses on trade signals and techniques that conform to the trend. In
other words, using bullish signals primarily when the price is in a bullish trend and
bearish signals primarily when a stock is in a bearish trend may help traders to avoid
the false alarms that the RSI can generate in trending markets.
Image by Sabrina Jiang © Investopedia 2021

Overbought or Oversold
Generally, when the RSI indicator crosses 30 on the RSI chart, it is a bullish sign and
when it crosses 70, it is a bearish sign. Put another way, one can interpret that RSI
values of 70 or above indicate that a security is becoming overbought or overvalued. It
may be primed for a trend reversal or corrective price pullback. An RSI reading of 30 or
below indicates an oversold or undervalued condition.

Overbought refers to a security that trades at a price level above its true (or intrinsic)
value. That means that it's priced above where it should be, according to practitioners
of either technical analysis or fundamental analysis. Traders who see indications that a
security is overbought may expect a price correction or trend reversal. Therefore, they
may sell the security.

The same idea applies to a security that technical indicators such as the relative
strength index highlight as oversold. It can be seen as trading at a lower price than it
should. Traders watching for just such an indication might expect a price correction or
trend reversal and buy the security.

Interpretation of RSI and RSI Ranges

During trends, the RSI readings may fall into a band or range. During an uptrend, the
RSI tends to stay above 30 and should frequently hit 70. During a downtrend, it is rare
to see the RSI exceed 70. In fact, the indicator frequently hits 30 or below.
These guidelines can help traders determine trend strength and spot potential
reversals. For example, if the RSI can’t reach 70 on a number of consecutive price
swings during an uptrend, but then drops below 30, the trend has weakened and could
be reversing lower. 

The opposite is true for a downtrend. If the downtrend is unable to reach 30 or below
and then rallies above 70, that downtrend has weakened and could be reversing to the
upside. Trend lines and moving averages are helpful technical tools to include when
using the RSI in this way.

 Be sure not to confuse RSI and relative strength. The first refers to changes
in the the price momentum of one security. The second compares the price
performance of two or more securities.

Example of RSI Divergences

An RSI divergence occurs when price moves in the opposite direction of the RSI. In
other words, a chart might display a change in momentum before a corresponding
change in price.

A bullish divergence occurs when the RSI displays an oversold reading followed by a

higher low that appears with lower lows in the price. This may indicate rising bullish
momentum, and a break above oversold territory could be used to trigger a new long
position.

A bearish divergence occurs when the RSI creates an overbought reading followed by
a lower high that appears with higher highs on the price.

As you can see in the following chart, a bullish divergence was identified when the RSI
formed higher lows as the price formed lower lows. This was a valid signal, but
divergences can be rare when a stock is in a stable long-term trend. Using flexible
oversold or overbought readings will help identify more potential signals.
Image by Sabrina Jiang © Investopedia 2021

Example of Positive-Negative RSI Reversals

An additional price-RSI relationship that traders look for is positive and negative RSI
reversals. A positive RSI reversal may take place once the RSI reaches a low that is
lower than its previous low at the same time that a security's price reaches a low that is
higher than its previous low price. Traders would consider this formation a bullish sign
and a buy signal.

Conversely, a negative RSI reversal may take place once the RSI reaches a high that
is higher that its previous high at the same time that a security's price reaches a lower
high. This formation would be a bearish sign and a sell signal.

Example of RSI Swing Rejections

Another trading technique examines RSI behavior when it is reemerging from
overbought or oversold territory. This signal is called a bullish swing rejection and has
four parts:

The RSI falls into oversold territory.

The RSI crosses back above 30.
The RSI forms another dip without crossing back into oversold territory.
The RSI then breaks its most recent high.
As you can see in the following chart, the RSI indicator was oversold, broke up through
30, and formed the rejection low that triggered the signal when it bounced higher. Using
the RSI in this way is very similar to drawing trend lines on a price chart.

Image by Sabrina Jiang © Investopedia 2021

There is a bearish version of the swing rejection signal that is a mirror image of the
bullish version. A bearish swing rejection also has four parts:

The RSI rises into overbought territory.

The RSI crosses back below 70.
The RSI forms another high without crossing back into overbought territory.
The RSI then breaks its most recent low.

The following chart illustrates the bearish swing rejection signal. As with most trading
techniques, this signal will be most reliable when it conforms to the prevailing long-term
trend. Bearish signals during downward trends are less likely to generate false alarms.
Image by Sabrina Jiang © Investopedia 2021

The Difference Between RSI and MACD

The moving average convergence divergence (MACD) is another trend-following
momentum indicator that shows the relationship between two moving averages of a
security’s price. The MACD is calculated by subtracting the 26-period exponential
moving average (EMA) from the 12-period EMA. The result of that calculation is the
MACD line.

A nine-day EMA of the MACD, called the signal line, is then plotted on top of the MACD
line. It can function as a trigger for buy and sell signals. Traders may buy the security
when the MACD crosses above its signal line and sell, or short, the security when the
MACD crosses below the signal line.

The RSI was designed to indicate whether a security is overbought or oversold in

relation to recent price levels. It's calculated using average price gains and losses over
a given period of time. The default time period is 14 periods, with values bounded from
0 to 100.

The MACD measures the relationship between two EMAs, while the RSI measures
price change momentum in relation to recent price highs and lows. These two
indicators are often used together to provide analysts with a more complete technical
picture of a market.
These indicators both measure the momentum of an asset. However, they measure
different factors, so they sometimes give contradictory indications. For example, the
RSI may show a reading above 70 for a sustained period of time, indicating a security
is overextended on the buy side.

At the same time, the MACD could indicate that buying momentum is still increasing for
the security. Either indicator may signal an upcoming trend change by showing
divergence from price (the price continues higher while the indicator turns lower, or vice
versa).

Limitations of the RSI

The RSI compares bullish and bearish price momentum and displays the results in an
oscillator placed beneath a price chart. Like most technical indicators, its signals are
most reliable when they conform to the long-term trend.

True reversal signals are rare and can be difficult to separate from false alarms. A false
positive, for example, would be a bullish crossover followed by a sudden decline in a
stock. A false negative would be a situation where there is a bearish crossover, yet the
stock suddenly accelerated upward.

Since the indicator displays momentum, it can stay overbought or oversold for a long
time when an asset has significant momentum in either direction. Therefore, the RSI is
most useful in an oscillating market (a trading range) where the asset price is
alternating between bullish and bearish movements.

What Does RSI Mean?

The relative strength index (RSI) measures the price momentum of a stock or other
security. The basic idea behind the RSI is to measure how quickly traders are bidding
the price of the security up or down. The RSI plots this result on a scale of 0 to 100.

Readings below 30 generally indicate that the stock is oversold, while readings above
70 indicate that it is overbought. Traders will often place this RSI chart below the price
chart for the security, so they can compare its recent momentum against its market
price.

Should I Buy When RSI Is Low?

Some traders consider it a buy signal if a security’s RSI reading moves below 30. This
is based on the idea that the security has been oversold and is therefore poised for a
rebound. However, the reliability of this signal will depend in part on the overall context.
If the security is caught in a significant downtrend, then it might continue trading at an
oversold level for quite some time. Traders in that situation might delay buying until
they see other technical indicators confirm their buy signal.

What Happens When RSI Is High?

As the relative strength index is mainly used to determine whether a security is
overbought or oversold, a high RSI reading can mean that a security is overbought and
the price may drop. Therefore, it can be a signal to sell the security.

What Is the Difference Between RSI and Moving Average Convergence

Divergence (MACD)?
RSI and moving average convergence divergence (MACD) are both momentum
measurements that can help traders understand a security’s recent trading activity.
However, they accomplish this goal in different ways.

In essence, the MACD works by smoothing out the security’s recent price movements
and comparing that medium-term trend line to a short-term trend line showing its more
recent price changes. Traders can then base their buy and sell decisions on whether
the short-term trend line rises above or below the medium-term trend line.
Stochastic Oscillator Definition
By  ADAM HAYES  Updated June 25, 2021
Reviewed by  CHARLES POTTERS
Fact checked by  AMANDA BELLUCCO-CHATHAM

What Is a Stochastic Oscillator?

A stochastic oscillator is a momentum indicator comparing a particular closing price of
a security to a range of its prices over a certain period of time. The sensitivity of the
oscillator to market movements is reducible by adjusting that time period or by taking
a moving average of the result. It is used to generate overbought and oversold trading
signals, utilizing a 0–100 bounded range of values.

KEY TAKEAWAYS
A stochastic oscillator is a popular technical indicator for generating overbought
and oversold signals.
It is a popular momentum indicator, first developed in the 1950s.
Stochastic oscillators tend to vary around some mean price level since they
rely on an asset's price history.
Stochastic oscillators measure the momentum of an asset's price to determine
trends and predict reversals.
Stochastic oscillators measure recent prices on a scale of 0 to 100, with
measurements above 80 indicating that an asset is overbought and
measurements below 20 indicating that it is oversold.

Stochastic Oscillator

Understanding the Stochastic Oscillator

The stochastic oscillator is range-bound, meaning it is always between 0 and 100. This
makes it a useful indicator of overbought and oversold conditions.

Traditionally, readings over 80 are considered in the overbought range, and readings
under 20 are considered oversold. However, these are not always indicative of
impending reversal; very strong trends can maintain overbought or oversold conditions
for an extended period. Instead, traders should look to changes in the stochastic
oscillator for clues about future trend shifts.

Stochastic oscillator charting generally consists of two lines: one reflecting the actual
value of the oscillator for each session, and one reflecting its three-day simple moving
average. Because price is thought to follow momentum, the intersection of these two
lines is considered to be a signal that a reversal may be in the works, as it indicates a
large shift in momentum from day to day.

Divergence between the stochastic oscillator and trending price action is also seen as
an important reversal signal. For example, when a bearish trend reaches a new lower
low, but the oscillator prints a higher low, it may be an indicator that bears are
exhausting their momentum and a bullish reversal is brewing.

Image by Sabrina Jiang © Investopedia 2021

Formula for the Stochastic Oscillator

C − L14
%K = ( ) × 100
H14 − L14
​

where:
C = The most recent closing price
L14 = The lowest price traded of the 14 previous
trading sessions
H14 = The highest price traded during the same
14-day period
%K = The current value of the stochastic indicator
Notably, %K is referred to sometimes as the fast stochastic indicator. The "slow"
stochastic indicator is taken as %D = 3-period moving average of %K.

The general theory serving as the foundation for this indicator is that in a market
trending upward, prices will close near the high, and in a market trending downward,
prices close near the low. Transaction signals are created when the %K crosses
through a three-period moving average, which is called the %D.

The difference between the slow and fast Stochastic Oscillator is the Slow %K
incorporates a %K slowing period of 3 that controls the internal smoothing of %K.
Setting the smoothing period to 1 is equivalent to plotting the Fast Stochastic Oscillator.
1

History of the Stochastic Oscillator

The stochastic oscillator was developed in the late 1950s by George Lane. As
designed by Lane, the stochastic oscillator presents the location of the closing price of
a stock in relation to the high and low prices of the stock over a period of time, typically
a 14-day period.

Lane, over the course of numerous interviews, has said that the stochastic oscillator
does not follow price, volume, or anything similar. He indicates that the oscillator
follows the speed or momentum of price.

Lane also reveals that, as a rule, the momentum or speed of a stock's price movements
changes before the price changes direction. 2  In this way, the stochastic oscillator can
foreshadow reversals when the indicator reveals bullish or bearish divergences. This
signal is the first, and arguably the most important, trading signal Lane identified.

Example of the Stochastic Oscillator

The stochastic oscillator is included in most charting tools and can be easily employed
in practice. The standard time period used is 14 days, though this can be adjusted to
meet specific analytical needs. The stochastic oscillator is calculated by subtracting the
low for the period from the current closing price, dividing by the total range for the
period, and multiplying by 100.

As a hypothetical example, if the 14-day high is $150, the low is $125 and the current
close is $145, then the reading for the current session would be: (145-125) / (150 - 125)
* 100, or 80.

By comparing the current price to the range over time, the stochastic oscillator reflects
the consistency with which the price closes near its recent high or low. A reading of 80
would indicate that the asset is on the verge of being overbought.

Relative Strength Index (RSI) vs. Stochastic Oscillator

The relative strength index (RSI) and stochastic oscillator are both price momentum
oscillators that are widely used in technical analysis. While often used in tandem, they
each have different underlying theories and methods. The stochastic oscillator is
predicated on the assumption that closing prices should move in the same direction as
the current trend.

Meanwhile, the RSI tracks overbought and oversold levels by measuring the velocity of

price movements. In other words, the RSI was designed to measure the speed of price
movements, while the stochastic oscillator formula works best in consistent trading
ranges.

In general, the RSI is more useful during trending markets, and stochastics more so in
sideways or range-bound markets. 3

Limitations of the Stochastic Oscillator

The primary limitation of the stochastic oscillator is that it has been known to
produce false signals. This is when a trading signal is generated by the indicator, yet
the price does not actually follow through, which can end up as a losing trade. During
volatile market conditions, this can happen quite regularly. One way to help with this is
to take the price trend as a filter, where signals are only taken if they are in the same
direction as the trend.

How Do You Read the Stochastic Oscillator?

The stochastic oscillator represents recent prices on a scale of 0 to 100, with 0
representing the lower limits of the recent time period and 100 representing the upper
limit. A stochastic indicator reading above 80 indicates that the asset is trading near the
top of its range, and a reading below 20 shows that it is near the bottom of its range.

What Does %K Represent on the Stochastic Oscillator?

On a stochastic oscillator chart, %K represents the current price of the security,
represented as a percentage of the difference between its highest and lowest values
over a certain time period. In other words, K represents the current price in relation to
the asset's recent price range.

What Does %D Represent on the Stochastic Oscillator?

On a stochastic oscillator chart, %D represents the 3-period average of %K. This line is
used to show the longer-term trend for current prices, and is used to show the current
price trend is continuing for a sustained period of time. 3
Bollinger Bands®: Calculations and Indications
By  ADAM HAYES  Updated August 31, 2022
Reviewed by  CHARLES POTTERS
Fact checked by  AMANDA JACKSON

Investopedia / Joules Garcia

What Is a Bollinger Band®?

A Bollinger Band® is a technical analysis tool defined by a set of trendlines plotted
two standard deviations (positively and negatively) away from a simple moving
average (SMA) of a security's price, but which can be adjusted to user preferences.

Bollinger Bands® were developed and copyrighted by famous technical trader John
Bollinger, designed to discover opportunities that give investors a higher probability of
properly identifying when an asset is oversold or overbought.

KEY TAKEAWAYS
Bollinger Bands® are a technical analysis tool developed by John Bollinger for
generating oversold or overbought signals.
There are three lines that compose Bollinger Bands: A simple moving average
(middle band) and an upper and lower band.
The upper and lower bands are typically 2 standard deviations +/- from a 20-day
simple moving average (which is the center line), but they can be modified.
When the price continually touches the upper Bollinger Band, it can indicate an
overbought signal while continually touching the lower band indicates an oversold
signal.
 1:59
Understanding Bollinger Bands

How to Calculate Bollinger Bands®

The first step in calculating Bollinger Bands® is to compute the simple moving average
(SMA) of the security in question, typically using a 20-day SMA. A 20-day moving average
would average out the closing prices for the first 20 days as the first data point. The next
data point would drop the earliest price, add the price on day 21 and take the average, and
so on. Next, the standard deviation of the security's price will be obtained. Standard
deviation is a mathematical measurement of average variance and features prominently in
statistics, economics, accounting, and finance.

For a given data set, the standard deviation measures how spread out numbers are from an
average value. Standard deviation can be calculated by taking the square root of the
variance, which itself is the average of the squared differences of the mean. Next, multiply
that standard deviation value by two and both add and subtract that amount from each point
along the SMA. Those produce the upper and lower bands.

Here is this Bollinger Band® formula:

BOLU = MA(TP, n) + m ∗ σ[TP, n]
BOLD = MA(TP, n) − m ∗ σ[TP, n]
where:
BOLU = Upper Bollinger Band
BOLD = Lower Bollinger Band
MA = Moving average
TP (typical price) = (High + Low + Close) ÷ 3
n = Number of days in smoothing period (typically 20)
m = Number of standard deviations (typically 2)
σ[TP, n] = Standard Deviation over last n periods of TP

What Do Bollinger Bands® Tell You?

Bollinger Bands® are a highly popular technique. Many traders believe the closer the prices
move to the upper band, the more overbought the market, and the closer the prices move to
the lower band, the more oversold the market. John Bollinger has a set of 22 rules to
follow when using the bands as a trading system. 1

In the chart depicted below, Bollinger Bands® bracket the 20-day SMA of the stock with an
upper and lower band along with the daily movements of the stock's price. Because
standard deviation is a measure of volatility, when the markets become more volatile the
bands widen; during less volatile periods, the bands contract.

Image by Sabrina Jiang © Investopedia 2021

The Squeeze
The "squeeze" is the central concept of Bollinger Bands®. When the bands come close
together, constricting the moving average, it is called a squeeze. A squeeze signals a period
of low volatility and is considered by traders to be a potential sign of future increased
volatility and possible trading opportunities.

Conversely, the wider apart the bands move, the more likely the chance of a decrease in
volatility and the greater the possibility of exiting a trade. However, these conditions are not
trading signals. The bands give no indication when the change may take place or in which
direction the price could move.

Breakouts
Approximately 90% of price action occurs between the two bands. 1  Any breakout above or
below the bands is a major event. The breakout is not a trading signal. The mistake most
people make is believing that that price hitting or exceeding one of the bands is a signal to
buy or sell. Breakouts provide no clue as to the direction and extent of future price
movement.

Limitations of Bollinger Bands®

Bollinger Bands® are not a standalone trading system. They are simply one indicator
designed to provide traders with information regarding price volatility. John Bollinger
suggests using them with two or three other non-correlated indicators that provide more
direct market signals. He believes it is crucial to use indicators based on different types of
data. Some of his favored technical techniques are moving average
divergence/convergence (MACD), on-balance volume, and relative strength index (RSI).

Because they are computed from a simple moving average, they weigh older price data the
same as the most recent, meaning that new information may be diluted by outdated data.
Also, the use of 20-day SMA and 2 standard deviations is a bit arbitrary and may not work
for everyone in every situation. Traders should adjust their SMA and standard deviation
assumptions accordingly and monitor them.

What Do Bollinger Bands® Tell You?

Bollinger Bands® give traders an idea of where the market is moving based on prices. It
involves the use of three bands—one for the upper level, another for the lower level, and the
third for the moving average. When prices move closer to the upper band, it indicates that
the market may be overbought. Conversely, the market may be oversold when prices end
up moving closer to the lower or bottom band.

Which Indicators Work Best with Bollinger Bands®?

Many technical indicators work best in conjunction with other ones. Bollinger Bands are
often used along with the relative strength indicator (RSI) as well as the BandWidth
indicator, which is the measure of the width of the bands relative to the middle band. Traders
use BandWidth find Bollinger Squeezes.

How Accurate Are Bollinger Bands?

Since Bollinger Bands® are set two use +/- two standard deviations around an SMA, we
should expect that approximately 95% of the time, the observed price action will fall within
these bands.

What Time Frame Is Best Used with Bollinger Bands?

Bollinger Bands® typically use a 20-day moving average.

The Bottom Line

Bollinger Bands® can be a useful tool for traders for assessing the relative level of over- or
under-boughtness of a stock and provides them with insight on when to enter and exit a
position. Certain aspects of Bollinger Bands, such as the Squeeze, work well for currency
trading, as does adding a second set of Bollinger Bands. Buying when stock prices cross
below the lower Bollinger Band® often helps traders take advantage of oversold conditions
and profit when the stock price moves back up toward the center moving-average line.
Using this tool correctly can help investors and traders make better decisions and hopefully
earn profits.
Fibonacci Sequence: Definition, How it Works,
and How to Use It
By  CORY MITCHELL  Updated July 24, 2022
Reviewed by  CHARLES POTTERS
Fact checked by  JARED ECKER

What Is the Fibonacci Sequence?

The Fibonacci sequence was developed by the Italian mathematician, Leonardo Fibonacci,
in the 13th century. The sequence of numbers, starting with zero and one, is a steadily
increasing series where each number is equal to the sum of the preceding two numbers.

Some traders believe that the Fibonacci numbers and ratios created by the sequence play
an important role in finance that traders can apply using technical analysis.

KEY TAKEAWAYS
The Fibonacci sequence is a set of steadily increasing numbers where each number
is equal to the sum of the preceding two numbers.
The golden ratio of 1.618 is derived from the Fibonacci sequence.
Many things in nature have dimensional properties that adhere to the golden ratio of
1.618.
The Fibonacci sequence can be applied to finance by using four techniques
including retracements, arcs, fans, and time zones.

Understanding the Fibonacci Sequence

The numbers in the Fibonacci Sequence don't equate to a specific formula, however, the
numbers tend to have certain relationships with each other. Each number is equal to the
sum of the preceding two numbers. For example, 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144,
233, 377.

Fibonacci Sequence Rule

xn = xn−1 + xn−2

where:

xn is term number "n"

xn−1 is the previous term (n−1)

 xn−2 is the term before that (n−2)

The golden ratio of 1.618, important to mathematicians, scientists, and naturalists for

centuries is derived from the Fibonacci sequence. The quotient between each successive
pair of Fibonacci numbers in the sequence approximates 1.618, or its inverse 0.618.

Golden Ratio
The golden ratio is derived by dividing each number of the Fibonacci series by
its immediate predecessor. Where F(n) is the nth Fibonacci number, the
quotient F(n)/ F(n-1) will approach the limit 1.618, known as the golden ratio.

Many things in nature have dimensional properties that adhere to the ratio of 1.618, like the
honeybee. If you divide the female bees by the male bees in any given hive, you will get a
number near 1.618. The golden ratio also appears in the arts and rectangles whose
dimensions are based on the golden ratio appear at the Parthenon in Athens and the Great
Pyramid in Giza. 1

How to Use the Fibonacci Sequence

The Fibonacci sequence can be applied to finance by using four techniques including
retracements, arcs, fans, and time zones.

Fibonacci retracements require two price points chosen on a chart, usually a swing high and
a swing low. Once two points are chosen, the Fibonacci numbers and lines are drawn at
percentages of that move. If a stock rises from $15 to $20, then the 23.6% level is $18.82,
or $20 - ($5 x 0.236) = $18.82. The 50% level is $17.50, or $15 - ($5 x 0.5) = $17.50.

Image by Sabrina Jiang © Investopedia 2021

Fibonacci retracements are the most common form of technical analysis based on the
Fibonacci sequence. During a trend, Fibonacci retracements can be used to determine how
deep a pullback may be. Traders tend to watch the Fibonacci ratios between 23.6% and
78.6% during these times. If the price stalls near one of the Fibonacci levels and then start
to move back in the trending direction, an investor may trade in the trending direction.

Arcs, fans, and time zones are similar concepts but are applied to charts in different ways.
Each one shows potential areas of support or resistance, based on Fibonacci numbers
applied to prior price moves. These supportive or resistance levels can be used to forecast
where prices may fall or rise in the future.

Practice trading with virtual money

SELECT A STOCK

TSLA AAPL NKE AMZN WMT

TESLA … APPLE … NIKE INC AMAZO… WALM…

SELECT INVESTMENT AMOUNT SELECT A PURCHASE DATE

$              2 years ago         

 CALCULATE

What Is the Fibonacci Spiral?

The limits of the squares of successive Fibonacci numbers create a spiral known as the
Fibonacci spiral. It follows turns by a constant angle close to the golden ratio and is
commonly called the golden spiral. The numbers of spirals in pinecones are Fibonacci
numbers, as is the number of petals in each layer of certain flowers. In spiral-shaped plants,
each leaf grows at an angle compared to its predecessor, and sunflower seeds are packed
in a spiral formation in the center of their flower in a geometry governed by the golden ratio.
2

Where Is the Fibonacci Sequence Evident?

In almost all flowering plants, the number of petals on the flower is a Fibonacci number. It is
extremely rare for the number of petals not to be so and examples of this phenomenon
include corn marigold, cineraria, and daisies with 13 petals and asters and chicory with 21
petals. 3

How Can the Fibonacci Sequence Affect Trading Behavior?

Humans tend to identify patterns and traders easily equate patterns in charts through the
Fibonacci sequence. It's unproven that Fibonacci numbers relate to fundamental market
forces, however, markets by design react to the beliefs of their players. Consequently, if
investors buy or sell because of Fibonacci analysis, they tend to create a self-fulfilling
prophecy that affects the market trends. 2

The Bottom Line

The Fibonacci sequence is a set of steadily increasing numbers where each number is
equal to the sum of the preceding two numbers. Many things in nature have dimensional
properties that adhere to the golden ratio of 1.618, a quotient derived from the Fibonacci
sequence. When applied to finance and trading, investors apply the Fibonacci sequence
through four techniques including retracements, arcs, fans, and time zones.