Technical Indicator: Definition, Analyst Uses, Types and Examples

What Is a Technical Indicator?

Technical indicators are heuristic or pattern-based signals produced by the price, volume, and/or open interest of a security or contract used by traders who follow technical analysis.

By analyzing historical data, technical analysts use indicators to predict future price movements. Examples of common technical indicators include the Relative Strength Index (RSI), Money Flow Index (MFI), stochastics, moving average convergence divergence (MACD), and Bollinger Bands®.

Understanding the Function of Technical Indicators

Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Unlike fundamental analysts, who attempt to evaluate a security’s intrinsic value based on financial or economic data, technical analysts focus on patterns of price movements, trading signals, and various other analytical charting tools to evaluate a security’s strength or weakness.

Technical analysis can be used on any security with historical trading data. This includes stocks, futures, commodities, fixed-income, currencies, and other securities. In this tutorial, we’ll usually analyze stocks in our examples, but keep in mind that these concepts can be applied to any type of security. In fact, technical analysis is far more prevalent in commodities and forex markets, where traders focus on short-term price movements.

Technical indicators, or "technicals," focus on historical trading data like price, volume, and open interest, not business fundamentals like earnings, revenue, or profit margins. Active traders commonly use technical indicators to analyze short-term price movements, but long-term investors may use them to find entry and exit points.

Different Categories of Technical Indicators

There are two basic types of technical indicators:

1. 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®.
2. Oscillators: 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.

Traders frequently use various technical indicators to analyze a security. With thousands of options, traders need to pick the best indicators and learn how they work. Traders might combine technical indicators with subjective analysis, like chart patterns, to develop trade ideas. Due to their quantitative nature, technical indicators can be used in automated trading systems.

Real-World Examples of Technical Indicators in Action

The following chart shows some of the most common technical indicators, including moving averages, the RSI, and the MACD.

Here, the 50- and 200-day moving averages are plotted over prices to show the current price relative to historical averages. The 50-day moving average is above the 200-day, suggesting a positive overall trend. The RSI above the chart indicates the trend strength, showing a neutral 49.07 here. The MACD below the chart shows how the two moving averages have converged or diverged—slightly bearish, in this case.

The Bottom Line

The Bottom Line: Technical indicators play a crucial role in the toolkit of traders and investors who employ technical analysis to forecast price movements of securities. These mathematical calculations based on data such as price, volume, and open interest help identify potential entry and exit points. With overlays like moving averages and oscillators like RSI and MACD, technical indicators can be tailored to suit various trading strategies. While predominantly used by active traders, these indicators also provide long-term investors with valuable insights into market trends. By understanding and applying these tools effectively, traders and investors can enhance their decision-making process.