12 day trading indicators used by professional traders

As a beginning trader, it is easy to become obsessed with indicators. Many traders spend years trying to find that 1 holy grail indicator (or combination of indicators) which will make them profitable. In this post, we will look at the top 12 indicators used by professional indicators and how they are used. It might surprise the beginning traders that these might not be the holy grail they are searching for. But note that trading takes more than just a (combination of) indicators. It takes discipline, risk & money management, a good understanding of the market. In the end, I think that indicators are just a small part of it. Like the word says they indicate things but in the end, it's far more important to understand the context of the market and understand the bigger picture. That’s perhaps why there are many professional traders who don’t use any indicators at all. They fully rely on their understanding of the market and only use methods like price action, order flow, or Gann for this. Any way lets dive in and look at the 12 of indicators used by professional traders.

 

1.Average True Range ( ATR )

The average true range is a very popular indicator that is used by many professional day traders in the world. The reason for this is that the ATR is a kind of special indicator. In contrary to most other indicators it does not try to give you entries or exits or try to predict if the market is going up or down. Instead, the ATR gives us a measure of the market’s volatility. You will find that the ATR is normally placed as a graph below the chart as a line chart. The higher the ATR goes, the higher the volatility, and the lower the ATR the lower the volatility. Traders typically use a 14-period ATR. What this means is that this will give us the highest volatility the market made during the last 14 bars. When we know what the highest volatility was during the last 14 bars then we can assume that it's very likely that the next bars will end up somewhere inside that range. Also, it's unlikely (but still possible) that the next bars will be outside this ATR range. Because of this, the ATR is an ideal indicator to determine where to place your stop-loss. As you can imagine we want to place our stop outside the normal market noise to avoid getting stopped out by the volatility. The ATR is perfect for this and many traders place their stop at 1-2 times the ATR from their entry.

If you look at the example below you can see how this would work. Let’s suppose the trader decided to go short at the dashed vertical line. To prevent getting stopped out by the market volatility we look at the ATR which is the brown line under the price chart. At the time of entry, we see that the ATR is 13. Meaning that the average true range is 13 points. To prevent getting stopped out we place our stop at our entry – 2* ATR which is indicated by the red rectangle. Note that some traders use -1.5 instead of 2. Next, we calculate our target. In this case, I choose a risk/reward ratio of 1:2 so the target will be 2 times bigger as the potential loss as indicated by the green rectangle. In this case, price didn’t come close to our stop but went straight to target. But I hope you see how the ATR can help you calculate a good stop-loss placement for the current market volatility.

 Example on how to use the ATR to place your stop loss

 

2.Simple Moving Average (SMA) and Exponential Moving Average (EMA)

The second indicator which you will find on the charts of almost all professional traders is a simple or exponential moving average. But which one should you use? The EMA or SMA?

Well, between the SMA and EMA, there's no better one; they're just different, and you can choose whichever one you like. Now, whether it makes a difference or not depends on the time frame. When you're using a very long look-back period, for example, the 200-day moving average or the 300 a moving average, which are long time frames, then it doesn't matter, as there's not that big of a difference between the EMA and the SMA. The shorter the time frame, the bigger or the longer the time frame, the less the difference is because they are both almost the same.

Well, let's take a look at how they vary. So, the simple moving average is just an average of a given number of closing price action. For example, with a 20-day moving average, with an SMA, they will just take the last 20 candles (the last 20 closing prices) and add them up, and divide by 20-- it's just an average, a simple average, and it's moving because it keeps changing every day. With the exponential moving average, it's weighted, with more importance given to recent candles. So, the more recent price action is given more weight or more emphasis on the average, it's a weighted average. SO, exponential moving averages take the recent price action into account. Generally, the exponential moving average is a little bit more reactive, it reacts first which you might or might not like. The simple moving average there is slower and steadier; it reacts a little bit more slowly and so it's not necessarily going to give you as many signals if you use it as a trading signal. However, you may not want so many signals, you may want to wait for a more solid signal, more confirmation, and so more signals is not necessarily a better thing.

It's up to you whether you want something more reactive and something that gives more signals as an exponential moving average would. Or a simple moving average, which is slower and steadier, and less reactive; it doesn't move with every moving candlestick.

For example, when a stock goes down, the exponential moving average reacts first, and it reacts more strongly, it goes down first, whereas the simple moving average will take its time to react to it. This makes the exponential moving average wobblier. whereas the simple moving average pretty much stays steadier.

Many day traders prefer exponential moving averages because they want to emphasize recent price action. They don't want to look back too far because they're day traders. A lot of day traders are scalpers they're just going to get in quickly, get out quickly, make small amounts of money over and over. And that's fine, and so that's understandable that day traders might often prefer the exponential moving average because it takes very recent price action very heavily into account. Because they have to think up to the minute, and up to the second. So, it's up to your preference whether one is better or worse it depends what you're looking for in your moving averages and your buy and sells signals or whatever you use when you're using moving averages.

Below you see a chart with 2 common moving averages. The 21 EMA and 200SMA. The 200SMA (the green line) is used by many traders as a way to determine the bigger trend. If the price is above the 200SMA they are only looking to take long traders and if the price is below the 200SMA they are only looking for short trades. The 21 EMA is used to find entries into the shorter trends. Traders wait for the price to pull back to the 21 EMA and then look for a possible entry there.

 Example of a chart with a 200SMA and 21 EMA

 

3.Fibonacci Retracement

Fibonacci numbers were discovered a long time ago. They are special numbers and ratios that occur everywhere in nature and in life. Since the Fibonacci numbers seem to play a huge part in life traders started to use them to find entries and exits at the Fibonacci levels. Traders will wait for the price to reach a Fibonacci number by drawing a so-called Fibonacci retracement. This is a drawing tool that you can find in all trading platforms nowadays. For a long setup, we simply draw the Fibonacci retracement from the lows to the highs. And for a short setup, we draw the retracement from the highs to the lows.  Next, we wait for the price to pull back to one of the Fibonacci numbers. While there are many Fibonacci levels, just a few of them are used by traders. Here are some of the most important ones.

  • The 61.8% retracement. If we take a Fibonacci retracement we will see that price often stalls or reverses at the 61.8% retracement as is shown in the following example. Traders might look at opening a trade at the 61.8% with an ATR based stop-loss as discovered in one of the previous paragraphs
  • The -23.6% extension or first target. When price bounces of the 50% or 61.8% to continue with the trend we often see some first profit-taking at the -23.6% so this is a perfect place for our first target
  • The -61.8% extension or second target. Again a Fibonacci number where we expect to see profit-taking and thus this makes a good 2nd target
  • The 50% retracement. Although technically not a real Fibonacci number the market seems to respect this number. In a strong trend, prices might not go all the way back to the -61.8% but stall and reverse at 50% or even the 38.2%

 

Example of a chart showing how Fibonacci can be used to find entries and targets

 

4. Stochastic Oscillator

The stochastic oscillator like most other oscillators tries to predict when the market is overbought or oversold. Typically, the reading above 80 level shows overbought and we would start looking for a short trade. A value below 20 means the market is oversold and we'll be looking for a long setup. The indicator consists of two lines:

  • The K-line compares the latest closing price to the recent trading range the
  • The D-line is a signal line calculated by averaging the K-line values.

You can use the Stochastic indicator for some many things:

  1. Using the overbought and oversold readings in a range-bound market: In a range, we buy when the D line is rising out of the overbought area, and we sell when the D line is coming out of the oversold area.
  2. Using the line crossovers in a range-bound market: in the range, we buy when the k-line crosses above the D line, and we sell when the K line crosses below the D line.
  3. Using the overbought and oversold conditions in a trending market: When the market is trending upwards, you wait for a retracement lower, and an oversold reading on the stochastic indicator. You buy when the D line is rising above the 20 levels. When the market is trending down you wait for a retracement higher and an overbought reading on the stochastic indicator. You sell when the D line is falling below the 80 levels, remember to always stay with the trend.

When the market is in an uptrend you only look at buying opportunities, and when the market is in a downtrend you only look for selling opportunities. Many professional traders who use the stochastic oscillator trade it together with other indicators like a moving average and/or divergence

 

Example of a chart with the stochastic oscillator

 

5.Bollinger bands

Bollinger Bands were invented by market technician John Bollinger in the 1980s, they are a very popular indicator that helps traders to determine possible buy and sell points as well as when a market might make a big move soon. To understand Bollinger Bands first we need to take a quick look at standard deviations. Don't worry-- it's simple. A standard deviation is just a measure of how far away the price is from its average or typical price.

A 1 standard deviation is a little bit higher or lower than the average or typical price and this happens frequently.

A 2 standard deviations mean a lot higher or lower than the average or typical price and this happens occasionally.

A 3 standard deviations are a whole lot higher or lower than the average or typical price, and this happens rarely, but it does happen.

In a normal distribution, we will see that 68.2% of the time the price will stay within 1 standard deviation. So, we take the current price then it can go one standard deviation lower, or one standard deviation higher, but it'll stay within one standard deviation of the mean or average about 68.2% of the time.  It will stay within two standard deviations 95.5% at the time. And The price will stay within three standard deviations 99.7% of the time.

So, that's what standard deviations mean. It tells us how likely it is that price stays within 1,2,3 or more deviations from the average price. Now let us go back to the Bollinger bands and take a look at the chart below. The brownish midline is just a 20 simple moving average and is used as the average price. Next, we see a green line above and below the midline which are called the upper and lower bands. The region between the upper- and lower line is filled with a green color. Note that the upper line is placed at 2 standard deviations above the midline and the lower green line of the bands is placed 2 standard deviations below the midline. 

Now if the market would really follow a normal distribution as we discussed above, then the price would stay within the upper and lower Bollinger Bands 95.5% of the time because remember it's two standard deviations above and below the midline here or average.

But realistically speaking, the market is not normal or rational in its behavior. In reality, price should be expected to stay within the bands around 90% of the time. If you look at the chart then that seems to play out that way. It does stay within the bands most of the time, but not all the time.

Since the price is usually contained within the upper and lower bands, we can say about 90% of the time, some traders will buy when it touches the lower band, and then sell when it touches the upper band. This kind of makes sense because if it stays within the bands most of the time, you can buy at the lower band, and sell at the upper band, and you can just rinse and repeat that over and over.

But please note that this method is not 100% reliable, and prices can often break right through the bands. Oftentimes, the method works better in ranging markets or low volatile markets. That makes sense because less volatile markets that don't make huge moves are more likely to remain contained within the bands.

But even less volatile stocks can just bust right through the bands either to the upside or the downside and just keep going. For example in earnings reports can cause a candlestick to just shoot right through the bands.

It could just break right through it, so don't count on this 100% of the time. Sometimes the upper and lower Bollinger Bands will squeeze or contract; they'll come very close together. When the upper and lower bands have been squeezed together for a while this means that volatility is low but it won't stay low forever. At least I can't think of any stock that has very low volatility forever; at some points, volatility is going to pick up most likely. Therefore, we might expect volatility to increase soon after it's been squeezed for a while, and a big move might happen in the near future.

However, there are no guarantees in the market. The big move could be to the upside or the downside. Since it's difficult to know whether the big move will be a breakout to the upside or a breakdown to the downside, some options traders will buy a straddle or a strangle.

Once again this method is not 100% reliable since Bollinger Bands squeezes can last for a very long time before any breakouts or breakdown occurs. That is why most traders use the Bollinger Bands together other indicators, for example, RSI, MACD, or whatever you like.

Example of a chart with Bollinger bands.

6.Relative Strength Index ( RSI )

The RSI is a technical indicator that was invented originally for stocks. It was featured by J Wells Wilder in the 1978 book New Concepts in Technical Trading Systems. Since then it has become very popular and is now used in all kind of markets.

For those of you curious,  the formula is

RSI = 100-(100/1 + RS)

where RS = Average Gain / Average Loss.

Thankfully you don't need to know it to use it.

Just like the Stochastic, the RSI is also an oscillator which is just a fancy way of saying that it's a line that goes up, and then down, then up, and down, and so on. It's also a momentum indicator which means that it indicates the general overall direction or trend of a market. So, when the RSI is going up, that means that the price is trending upward, and when the RSI line is going down, that means that the stock price is generally trending downwards.

It's very often used as an overbought or oversold indicator. This means that it will tell you when a stock is overbought, and overbought means expensive, it means it's at a high price. Or when it's oversold and oversold is just a fancy way of saying that it's relatively cheap, or it's on sale, or a bargain, etc. Medium-term or swing traders will often use the RSI 14, for the 14 period RSI, which calculates the RSI using the most recent 14 bars of the chart.

A popular strategy is to wait until the RSI goes below 30 which is considered oversold or cheap, then wait until it comes back up above 30, and then you open a buy trade. vice versa when the RSI goes above 70, which is considered overbought or more expensive, and then wait until it goes back below 70 out of the overbought territory they open a sell trade. Note however that the RSI might stay in overbought or oversold conditions for a long time. Another popular strategy traders use is to trade the divergence between the RSI and price. As discusses before most professional traders use a combination of indicators. 

 

Example of a chart with the RSI indicator.

7.MACD

So, the MACD is a quick way of saying Moving Average Convergence Divergence. And, it is a momentum indicator that means that it tells the general direction. So are we looking at a stock that is short to medium term and whether that stock tends to trend upward, downward, or sideways? This is what the MACD does; it tells the general direction in the short to medium term.

There are several parts to the MACD indicator:

  • You have the black line, which is called the MACD line.
  • You have the red line and that is called the Signal line.
  • And then you have these blue bars which kind of look like a bar graph. The blue bars that's called the Histogram.

So, these are the three parts you need to pay attention to with the MACD. So, what do these three lines do?

 

1.The MACD Line

For the black line, that's the MACD line, what it does is, on the standard MACD settings, it is the 12-day EMA minus the 26-day EMA. So, that's the mathematical formula for the black line, but you don't necessarily need to know all of the math involved in it you just want to know for now. For those of you who don't know what EMA is, it is the Exponential Moving Average. Most stock charts by default put it on the standard MACD settings.

All you need to know is that the black line, the MACD line, gives the short-to-medium term trend of the price action. In other words has the stock been trending up or down or sideways.

This helps you to see which way in the short to medium term, in the past, with the black line, you can glance at it and quickly tell whether it has recently whether the stock or commodity or ETF for currency or whatever, whether the price action lately has been going down, or up or sideways.  So, in summary, it is a quick way to gauge the short-to-medium term trend of the price action that's the MACD line.

 

2.The Signal Line

On the standard MACD settings, it is the nine-day exponential moving average of the MACD line or the black line. So, the signal line the red the line is just a smoothed out, less choppy version of the MACD line.

It's more smoothed out because it's a moving average of the MACD line. To put it very simply, people who use the MACD can use it as a buy or sell signal, and of course, it's not a perfect indicator, it does not work every single time. I don't know any indicator that does so, be aware. So, it can be used however as a possible buy or sell signal. People might buy when the MACD line crosses above the signal line, and they might sell when the MACD line crosses below the signal line.

 

3.The Histogram

On the standard MACD settings, it is the MACD minus the signal line. It just shows how far above or below the MACD line is in relation to the signal line.

The MACD is a quick way to gauge the trend of the price action, and the histogram can help to assess the velocity of the upward or downward movement. In other words how quickly is it going up or down?

The relation of the MACD line to the signal line, in other words, is the MACD line crossing above or below the signal line can be used as a possible buy or sell signal as well.

Example of a chart with the MACD indicator.

 

8. Ichimoku Cloud

An Ichimoku chart is a system that has to do with observing the trend with an indicator similar to moving averages. Not only can this system be used for measuring price movements but it can also be used to predict them as well.

When it comes to the Ichimoku cloud it has a beneficial indicator that offers a unique interpretation of support and resistance. I've read around on the Ichimoku clouds and most of them are too long and have too many complicated terminologies which I think are likely to turn off a lot of people and so I wanted to present something very quick, simple and understandable as the same time.

When working with the cloud you will sometimes see it to be green or red and other times the cloud going beyond the current day's price action, something we will talk about as we move on.

So, if the current price is above the cloud or the current candlestick is above the cloud the direction is then considered to be in an upward trend. An upward trend is considered to be bullish. However, if the current price is below the cloud or when you find these candlesticks below the cloud then the direction is down or in a downtrend and that's considered a bearish sign.

Early on I said you will talk about when the cloud is either green or red and so if we have the candlesticks for the day and the cloud is green then the direction again is up and that's known as bullish and on the other hand, if the cloud is red on another day it will be considered bearish. You would have several lines in addition to a chart showing the general direction of the price action.

A couple of the lines can also be interpreted as levels of support and resistance and are included in the five lines or components of the Ichimoku cloud system. Two lines can form the cloud and play the role of support and resistance lines which is known as the conversion line. For these indicators default value, it shows the midpoint prices over the last nine periods.

The conversion line shows the short term price momentum or simply put, it signals an area of minor support or resistance so having a current market price above the conversion line will consider it as the levels of support where you will have a short term upward trend making it advisable to buy signals at this point.

Meanwhile, if the current market price is below the conversion line it will be considered as levels of resistance where you will have a short term downward trend, and this point you will want to search for selling signals.

Moving on to the other lines of the Ichimoku cloud is the second component known as the baseline or the confirmation line. In the medium term, the confirmation line serves as a signal for the support or resistance levels and is the midpoint of the high and low prices over the last twenty-six periods. This component on its own can be used to examine price momentum.

Just like the conversion line, it can have an upward and downward trend but this time the upward trend is when the current market price is higher than the midpoint price over the last twenty-six periods. The downward trend will be for when the current market price is lower than the twenty-six-period midpoint.

The third component is the lagging span which helps traders to picture the relationships between past and present trends as well as foreseeing trend reversals yet to come. And it is created by plotting closing prices twenty-six periods behind the latest closing price of an instrument.

A key way of utilizing the indicator is by analyzing its relationship with the current market price. A price market that is found below the lagging span indicates the strength of price as it goes up the chart and a price below the lagging span shows how weak the price is.

A bullish confirmation sign will be achieved if the lagging span is about cross above the prior price line and bearish confirmation sign for when the lagging span is about to cross below the prior price line.

The fourth and fifth lines are known as Leading span A and Leading span B collectively known as the Kumo cloud and they help indicate an upward trend in the form of a green cloud or downward trend in the form of a red cloud respectively.

The Kumo which is plotted as a cloud helps indicate dynamic support and resistance, based upon price action shifted twenty-six periods forward and provides a glimpse of support and resistance in the future.

Some things you should know when reading the Kumo:

 

  • the longer the price stays below or above the Kumo cloud, the stronger or weaker the trend is
  • The expected support or resistance is strong when the cloud is wide,
  • The expected support or resistance is weak when the cloud is thin
  • And an important rule is you should never trade inside the Kumo cloud.

Example of a chart with the ichimoku cloud.

 

9. Commodity Channel Index Indicator (CCI)

This is an alternative to RSI, and don't be tricked into thinking that it's just for commodities. People use it for stocks, ETFs, and commodities as well. They use it for all kinds of things very successfully. If you don't like RSI, here's something that might be better.

A lot of people use the RSI as a buy signal, what they'll do is they'll wait until it goes below 30, into oversold territory, and then they wait until it comes back up above 30. So when it goes below 30, and then comes back up above 30 out of oversold territory that's a very common buy signal.

Because not only is it cheap, but it's also coming back up, so the momentum is coming back up out of the inexpensive range, which is what I look for. But the problem with the 14 periods RSI is that look at this you know you've got lots of perfectly viable dips when you could have made money and it usually does not give any buy signals.

What I mean is at no point did it go below 30, and then decisively back up above 30. And so, you can go literally for five months, and to have lots of chopping, and lots of dips you could have bought, but you'll be missing out, and so it can be very boring, and you could leave money on the table.

Well, you might want to try as an alternative to the RSI, which is the CCI. It's very similar to RSI, just the numbers are different. For a CCI, if it goes down below negative, a hundred here that is oversold territory, and then back up decisively back up out of the oversold region, back up above the negative 100 lines, and then you can buy, and hold it for a nice run-up.

So, the CCI on the standard settings will give you more buy signals in many situations than the RSI. It can also give you false signals and by the way, none of these are perfect indicators, you cannot rely on them a hundred percent you need to make your own decision as to when to buy and you can use more than one indicator.

So, with CCI, if you set your stops correctly, and let your winners run then you would have done quite well, whereas with the RSI no buy signals according to this method.

Example of a chart with the CCI indicator.

 

10. Pivot Points

Pivot points is a technical indicator that helps you determine potential support and resistance areas. But unlike Fibonacci, it uses set calculations of previous day's; high, low. and closing prices to plot these levels so they are much more objective. This indicator is especially useful for day traders. One of the ways of using pivot points is to enter the market in the direction of the breakout.

For example, if the price is broken the r1 level, you can buy the market and set the price targets at the next resistance lines. So, the first target would be hat the R2, and the second target would be at the R3.

Traders often use candlestick analysis to trade their reversals at pivot points. For example, if the price is falling, bullish engulfing signal at s1 , we could buy the market with the targets at pivot level and r1.

Example of a chart with daily pivot points

 

11. Average Directional Index (ADX)

The ADX is an indicator invented by a man called J Wells Wilder who was a major innovator in the field of technical analysis in the late 1970s. Several well-known indicators that are still used regularly to this day were introduced by this man including the average true range, the relative strength index, and the ADX.

The intended purpose of the ADX was to provide a rating for pretty much any market as to what J Wells Wilder called its directional movement which could simply be described as how much it is trending now.

An important thing to know is that the indicator plots three lines on a chart the first of which is the ADX itself. The average directional index is a valley that oscillates between zero and a hundred and the higher it is the more the market is trending and the lower it is the less the market trends and a key point is above 25 it is a trending market below that is not considered to be a trending market.

The two other lines are directional indicators there show a positive directional(di+) indicator and a negative directional(di-) indicator and they do give you a gauge as to how much the market is moving up or down. The interactions of these two lines with each other and with the ADX can provide you with some signals on how strong or weak a trend is.

For the signal to be considered as one that is trending it should be above the twenty-five mark, and so for the positive and negative directional line indicators they can have either a bullish or bearish trend but as long as they are below the twenty-five marks those signals won't be considered for trade.

Example of a chart with the average directional index indicator.

 

12. On-balance Volume

The OBV indicator is based on the idea that volume is just as important as whether a period or candlestick is closed green or red. The OBV indicator only rises a lot when a period or candle closes green meaning above the previous periods close with heavy volume. If the volume is light the OBV indicator won't rise a lot even if the stock's price went up a lot. Similarly, the obv indicator only falls a lot when a period or candle closes red, meaning below the previous periods close with heavy volume if the volume is light. The obv indicator won't fall a lot even if the stock price went down a lot.

The idea is that the stock price action will follow where the volume flow is going. In other words, volume precedes price. It's just a theory, but it makes for a unique, and interesting indicator to add to your toolbox.

A divergence between the direction of the OBV indicator and the direction of the price action of the candlesticks might indicate the future direction of the stock price. And there are a couple of examples of that this is a daily candlestick chart of the price action of Ford stock alright each candlestick represents one day of price action and

The OBV indicator is best used not in isolation, but rather in conjunction with other indicators as well as your judgment and common sense. So, feel free to add this to your toolbox of indicators.

Example of the On-balance Volume indicator.

 

 

 

 

Erwin Beckers

I am the owner of EB-Worx. Together with my wife and dog I live in the Netherlands where I love to day trade the ES-mini and develop software which helps me to become a better trader.

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