There is a lot of information that one must process before getting into trading. For starters, you should have a thorough understanding of the trading world, beware of how to actually trade, when to do it and when to abstain from trading. All this is generally done to ensure that you are making meaningful gains in the trading arena.

Backtesting trading strategies is a means of ensuring that whenever you trade, you won’t just be making blind moves in the market. Once you have understood all the facets that pertain to trading, then you can apply software applications to help you trade.

Trading strategies take a lot of time to complete. Such an approach defines how you enter a trade as well as your expectations from the venture. Before launching the strategy, you need to test it out so that you can protect yourself from potential lossmaking and eventual failure in the trading scene.

What is Backtesting, and why traders require it?

Backtesting is a means to test out your trading strategy and see how it performs when subjected to real trading data. Typically, backtesting makes use of historical data from previous years and puts to work your trading strategy. You will then have a general idea of how it would’ve performed in the selected timeframe.

Once you complete backtesting, you can then engage the trading strategy in a forward test. The latter uses real-time data as opposed to historical data. However, you will have to get by the backtesting step to consider forward testing.

Back in the day, when computers were still unheard of in global markets, backtesting was quite easy. However, the workload involved was daunting going by today’s standards.

Traders would draw up their diligent trades on charts and effect a buy or sell action. Once this was done, they would then comprehensively note the trade results into a log for recording.

All this was done manually as there were no computers back then. If you could display the results on a computer screen, you would be ages ahead of the rest.

Today, on the other hand, computers are the basic tools used in trading. Therefore, backtesting is a lot easier than in previous years. They have improved the efficiency and potency of trading strategies the world over.

Why traders need to backtest their strategies

Before you enter a trade, you need to backtest your strategy. Failure to do so could spell significant consequences, not to mention burning your account. However, this is basic knowledge. Backtesting could prove useful to your trading future especially if you got into trading as a long-term investor.

·         Strategy

Needless to say, backtesting evaluates your trading strategy. From a successful backtest, you will know whether whatever you developed would have returned a profit, or would it have performed contrary to your expectations.

Afterward, you can then evaluate the entire approach where need be or refine it all together. Either way, backtesting serves as a means of improving any trading approach for the better.

·         Experience

During backtesting, you get your strategy working on real data, albeit from the past. Either way, you are sort of going to be involved in trading, or historical trading if you may. Manual backtesting is a particularly reliable way of gaining meaningful experience in the trading business.

·         Confidence

With every successful strategy backtest, your confidence as a budding trader receives some much-needed boost. Since you will be trading with actual figures drawn from the past, every successful strategy means a potentially successful trade. Even though you aren’t using real-time data, the next time you trade with live figures, you will have some experience and this is key to trading.

Ways to backtest your trading strategy

Once you have developed a potential strategy that you believe to be the real deal, it is time to test it out. There are several ways to backtesting trading strategies. They are mainly divided into two methods; manual and automated backtesting.

·         Manual backtesting

Manually backtesting a trading strategy, however, you view it, is pretty exhausting. However, this method provides traders, especially beginners with a real feel of how the market works. If you are looking for some practical experience in trading, manual backtesting is the way to go.

Follow these steps to backtest your trading strategy manually:

o   Step 1

Obtain a trading chart that is easy to read and feed in the desired currency pair you wish to backtest on. If you have any indicators or tools that make up your strategy, include them on the chart. Roll the chart back several periods.

o   Step 2

Shift the chart bar after bar and seek out possible trading setups. This is the grueling part, as you will have to sift through hundreds of them at a time to find the perfect setup.

o   Step 3

Once you spot a possibly profitable setup, log all the information as pertains to your ‘virtual’ trade. An Excel spreadsheet is the best way to record the data. Note down starting date, entry point, reward-risk ratio, stop-loss, take-profit plus any other information you deem noteworthy. This will be used to analyze the strategy and gauge the success or failure of the same.

o   Step 4

Step 4 isn’t necessary if you have found a working strategy. If not, however, get back on the chart and sift, once more, through the bars as you fine-tune your approach until you find a worthy setup. Then you can proceed to Step 3.

Manual backtesting is, from the onset, time-consuming. This is especially true since you will have to sift through piles of data unaided by any computer. Moreover, any proper backtest needs to go through as much data as possible.

Ten years’ worth of trading information is the go-to standard if you are looking to day trade your strategy. If you decide to go through such data, you ought to be mentally prepared for the workload. However, it is the most definitive way traders get to learn actual trading.

·         Automated backtesting

Granted, manual backtesting takes time. Automated backtesting, on the other hand, uses computer programs to test out trading strategies. It is fast and traders can then evaluate a trading strategy faster than it would have taken using the manual method. Moreover, traders might have several approaches on tap and backtesting all of them manually just wouldn’t cut it.

Usually, to conduct an automated backtest, you first have to get a backtesting software. First, there are free versions that we shall consider in this article. Paid versions are also available and even demo accounts count as backtesting software.

Before getting on the testing platform, get some data from valid sources. Incorrect data invalidates your backtest, and you wouldn’t know exactly why. So go the extra mile with this one.

Backtesting on TradingView

TradingView is a web-based platform that allows you to not only create trading charts but conduct a backtest on your trading strategy. TradingView is an excellent back-tester because it comes at no cost to users. Moreover, the platform includes tens of tools and indicators you can include in your trading approach.

So how do you go about backtesting on TradingView?

o   Step 1 – create an account on TradingView

Before you can begin testing strategies on the TradingView platform, you need to be logged in. It is a pretty straightforward procedure.

o   Step 2 – Bar Replay

Once inside, head on to the Bar Replay option. This button is the main item when it comes to backtesting on TradingView. It allows you to access information for as far back as the server holds.  The TradingView databank should quickly provide ten years’ worth of trading data.

o   Step 3 – Adjust bar replay settings

Before running the replay command, make sure you have implemented all the indicators and tools you need on your strategy. TradingView is comprehensively equipped with indicators and other trading tools you would require to perform any trading approach. Add them and then roll back the date to when you would wish to commence backtesting.

o   Step 4 – Start the bar replay

Simply engage the button with your cursor. Once it begins, you will be able to view each price across the years. You can, therefore, analyze the information and predict the price’s next move, after which you can engage the bar replay to see what is happening next.

Backtesting with TradingView Pros

1. Free to use for TradingView users
2. Easily accessible anywhere via a web-based platform
3. You can conduct a manual backtest
4. Accurate financial data
5. Plenty of trading indicators are available
6. A wealth of trading instruments, i.e., stocks, forex, crypto, ETFs etc.

Cons

1. Lacks fundamental analysis
2. Limited data for some assets
3. Indicators with a security function in playback cannot be used

As mentioned before, backtesting plays an essential role in determining the success or failure of any trading strategy. If you are ready to put your plan to work, get it tested first and weed out any flaws in the approach.

Putting your strategy to work through a simulated trade allows you to optimize it and fine-tune your approach towards profitability. Also, when you see your plan successfully survive a backtest, expect a significant boost in your confidence before applying it onto real-time markets.

For newbie traders, backtesting provides an in-depth method through which they can gain much-needed experience in the trading scene.

In the case of manual backtesting, you will be required to sift through substantial data. Doing so exposes you to trades that occurred in the past. Through them, you can understand the world of trading to a greater degree, pick out patterns and price action throughout the timeframe selected.

So do not skip this essential part of trading, but rather embrace it. Remember, a well-thought-out and tested strategy is the key to earning a decent profit from the venture.

One of the hallmarks of trading is the ability to avoid loss-making trades. The basics of investment entail that once you place your money, the result follows a pre-determined gain trajectory. Any other consequence would result in a loss-making venture.

To succeed at trading, one would need to monitor previous volume patterns of the trading market. Usually, trading needs volume to keep going. To move from one price point to the next, trading markets require volume to make the shift.

Mastering trading volumes will give you a newfound conviction on the strength or weakness of an asset and further help decide where to place your money. Trading is a lucrative venture, and in the case of forex, trillions of dollars’ worth of trades are carried out daily. If you want a piece of this cake, then mastering forex is how you get into profitability.

So how do you master volumes while trading? You will need to understand the fundamentals surrounding trading volumes, volume indicators, and how you can capitalize on the signals these indicators send out to use in your trading strategy.

Read on to gain insight into how you can make the most of this trading parameter and achieve profitability in trading.

What is a volume in trading

Volume quantifies how much trading has taken place. More specifically, trading volume denotes the scale of trades that a given financial asset has been subjected to.

If you are dealing with stocks, then their volume would be given in terms of the number of shares traded. In the case of options traders, this would then be how many contracts changed hands over some time.

Trading markets often experience periods of increased activity. This points out that many traders are involved in active trading. The result is an increase in volume and a volatile market.

The volatility leads to significant shifts in price points and provides an opportunity to make good money in the process. This doesn’t only apply to the FX arena, but you can as well make money trading crypto, stocks, bonds et cetera.

Well, you don’t need large volumes to succeed at trading since even slimmer ranges will give you returns. However, trading tight ranges can sometimes be a risky affair owing to how little price movement occurs. In this case, therefore, the volume is pretty significant.

How can you measure trading volume?

Trading is affected by several factors that traders are hardly in control over. To be ahead of the game, you would need to identify when to trade more so when the value of trading instruments decline and sell when the opposite manifests itself.

Volume is an excellent place to start when deciding when to trade. In this case, you ought to quantify trading volume. Volume indicators are essential measures of trading volume, and they go on to give you precious signals when the market is favorable for entry or exit.

Volume indicators

Like all trading tools, volume indicators use mathematic formulas when quantifying trading volume. These indicators then portray the result on a trading chart, such as what you can find on TradingView. The display is easy to understand as compared to their seemingly complex formulas.

Check out some popular volume indicators you need on your trading chart.

1.       Chaikin Money Flow

Developed by Marc Chaikin, the Chaikin Money Flow indicator is considered the best in the game. It measures both institutional and accumulation-distribution.

In trading markets, an increase in the price of commodities follow a rise in trading volume. As such, the Chaikin Money Flow concentrates on the growing volume as prices close at either high or low ranges daily. It then provides a figure to correspond with the outcome.

The Chaikin indicator signals an expanding volume when the price finishes at a higher level of its daily range. The Chaikin value will then be in the highs. The vice versa holds when this price lies lower in the daily range.

Because it considers daily ranges, the Chaikin indicator is a popular short-term indicator due to the oscillation it displays.

2.       Klinger Oscillator

The Klinger Oscillator considers buying and selling volumes for a specific timeframe. Developed by Stephen Klinger, the indicator follows money flow trends for extended periods, all the while considering short-term shifts.

By comparing the scale of securities’ volume and their price movement, the Klinger oscillator comes up with a description of how different two moving averages are. This figure is not solely based on price.

Traders are keen on divergence that is shown on the oscillator to detect possible price reversal points.

3.       On Balance Volume (OBV)

OBV is a powerful yet straightforward volume indicator. When markets close at highs, the volume is added ad subtracted when closing at a low. This shows you which stocks are accumulating through the running total.

Analyzing volume; what you should know

To get a proper feel of how the market moves in a particular direction, volume analysis is essential. As a trader, the last thing you want is to invest your money in a declining stock that would ultimately spell disaster for your trade.

As such, preference is afforded to strong moves. In the case of a declining movement, you can plot when to enter the market. Analyzing trading volume generally helps you decide when to trade and boosts your effectiveness at it.

The next time you analyze trade volumes, watch out for the following guiding principles.

·         Confirming a trend

Typically, rising prices are indicative of an upsurge in trading volumes. When many people are buying a commodity, the market volume goes up. More importantly, their enthusiasm follows a similarly rising trajectory.

Prices for the commodity then increase because the product is ‘hot-cake.’ However, an increase in price coupled with declining interest among traders indicates a possible price reversal.

Now when the price drops on a minor volume doesn’t warrant any drastic moves. On the other hand, when the price drops while the volume is topping out, it shows that something is wrong with the item. Buyers at this point are onto something about the trading instrument and are unlikely to keep up trading in it.

·         Bullish signals

When the price increase is accompanied by declining volume, we know that something in the stock has changed. On the other hand, when it is the volume that is surging against a price drop, it is a good sign that the market is adjusting down, and you ought to get ready to buy into the market.

When the price drop fails to drop below its previous lower point, and the volume diminishes, then a bullish sign is revealed.

·         Price reversals and volume

no matter how high a price for a stock will go, it will eventually fall. The market follows an up-down movement in the prices of commodities. The time taken for a rising value to fall is what traders are on the lookout for.

Prices will, at first, fluctuate with slight ranges at first despite a substantial prevailing volume in the market. This is the initial sign that the market is about to reverse. The price direction is expected to shift.

·         Exhaustion moves and volume

Exhaustion often indicates the end of a trend in the market and, consequently, how far you can ride on a trade. Exhaustion moves are shown by drastic price moves coupled with equally sharp volume shifts upward.

As prices climb, more buyers are roped in riding the trend. When the price drops, many traders are forced out of the trend, and we can then witness volatility in the market and amplified volume as well.

·         Breakouts and false breakouts vis a vis volume

Once a breakout in a range is spotted, it could indicate a strong move. If the volume drops, then the strength of the movement is in doubt.

Also, if the volume doesn’t see any change, you cannot count on the move. Generally, there is a lack of interest in the said stock or trading option to warrant a rise in trading volumes, and as such, there is a higher chance of the breakout being false.

The increasing volume shows that traders are actively involved in taking up the commodity, and hence you can ride on the progressing trend.

·         Volume history

Trading history provides a perfect starting point when you are gauging the viability of investing in the market. However, the farther back trading history goes, the less significant it is to the present trading scene.

Volume, as such, should be analyzed with recent data. This is because markets 10-20 years back are similar to that which we trade in today, and hence their information is relevant to your trades.  If you were to go back 50 years, you would find a completely different environment.

Takeaway

Volume trading is one way you can guarantee your profits, all the while protecting yourself from losses. Volume traders are keen on price trends as well as how the market volume appears.

In a nutshell, when there is a significant trading volume, you are better placed to open a position in the market. On the flip side, decreased trading volume points to bearish divergence, and you should sell.

With the basic guidelines discussed, you should be able to make headway when analyzing the strength of the market or weakness, if present. While volume indicators are not an encompassing indicator, they add much-needed insight into the market dynamics and should be part of your decision-making process.

Momentum is a crucial part of trading, and participants in the market are always taking into account how fast price changes occur. Technical traders are especially keen on momentum. This is because momentum complements their trading strategy and further increases their trading confidence.

As a trader, knowledge on price momentum in the market should support your trading strategy, just as it does professional traders.

So how does it all go down? Read on and find out more about momentum, momentum indicators, and the potential benefits that are up for grabs with a thorough understanding of this concept.

What are momentum indicators

Momentum indicators form a section of the broader array of technical trading tools available for use by traders. These indicators are used on trading charts to display various facets surrounding momentum.

Most of the time, they are combined with other indicators as a way of refining trading signals sent out. This is mainly because momentum indicators, unlike trend indicators, do not show the direction of price movement.

Momentum indicators can reveal the strength or weaknesses of price changes. By doing so, they allow traders to go about investing with confidence as they are assured of an upward or downward trend as gathered from momentum indicators.

To better understand how momentum indicators work, you first need to have a basic understanding of momentum.

Momentum?

Momentum indicators, from their name, work around momentum. Momentum quantifies the rate of change that a price undergoes. This gives you an idea of how fast or slow the quantity of trading instrument shifts.

Since momentum is given by a rate of change in a parameter, the indicators then consider a timeframe during which such a change occurred. It then uses the information collected to plot a single line on a trading chart.

Momentum indicators are classified as oscillator type indicators because momentum indicators often work by sending out signals that assist traders in picking out the forces behind price movement. Such signals identify whether the market will continue moving in a certain direction or retract and diverge from the prevailing trend.

Even if a price is seemingly following an upward trajectory, you need to have a rock-solid conviction that it won’t give in and with it take away your investment. This way, if the price is expected to experience a reversal, you will then be prepared for what is to come.

There are three critical signals you need to be on the lookout for when using momentum indicators. They are outlined below.

·         Moving average cross

The average closing price over a select number of days is the moving average. To be able to identify the moving average cross, first, add a moving average line onto your trading chart alongside the indicator. With it, you should be able to tell when the price crosses the moving average line.

The moving average cross is, therefore a signal telling you when to buy or sell. Typically, you can buy when the indicator crosses above the moving average and sell when it comes from above heading down past the moving average line.

The moving average cross, however, is not a foolproof indicator of when to buy and sell. One should follow the predominant trend in the market. Furthermore, you should first test out the signal before putting it to use on a live trade.

·         Divergence

Momentum divergence comes in two forms. They may either bear bearish or bullish inclinations. In the case of a bullish divergence, the price drops, but the momentum indicator’s low points are appreciating in contrast to the former.

O the other hand, a bearish divergence will occur when the price is moving upward, but the momentum’s top-level is in decline. This indication shows that even though there is an increasing price for a stock, the number of people interested in buying is slowly falling and you are inclined to sell.

The two-sidedness characteristic of momentum divergence gives traders indications early on of a market that is about change direction. By following divergence signals, you will be able to tell how strong a price momentum is and whether it can keep up the pace and further add or reduce the value of a stock or other option.

Both scenarios offer critical insight into market behavior and further signal when you can enter into a trade. However, divergence should not be used as the sole sale indicator but rather in combination with other indicators to be able to build up a conviction for your trade signals.

·         100-line cross

Another signal provided by momentum indicators is the 100-line cross. Momentum indicators give this signal when the price action curve crosses the 100-line either moving above or below it.

Both scenarios point to bullish or bearish indications depending on where the direction the price is moving past the 100-line.

When the price moves down past the 100-line, commodity prices are in decline, and you may want to trade from a bearish position. The opposite holds when the price climbs past the 100-line.

Types of momentum indicators

There are plenty of momentum indicators out there. However, there are three key indicators popular among pro-traders and which, as a beginner, you ought to familiarize with.

1.      Moving Average Convergence Divergence (MACD)

Pronounced mak-dee, MACD is one indicator popular with traders. The indicator follows a trend and shows the connection between the moving averages of a pair of prices for a stock or other trading instrument.

MACD can indicate price momentum oscillating between the two moving averages. During the process, the pair of moving averages will converge, overlap, and diverge from each other.

The indicator typically uses 12-day and 26-day exponential moving averages (EMAs). The difference between the two EMAs gives the MACD line plotted on the price chart. Combining this MACD with a 9-period EMA helps forecast price movement turns as the EMA acts as a signal line.

MACD is positive when the 12-day EMA value is above the 26-day EMA. It is negative when the conditions are rotated. When the two EMAs move away from each other, the MACD, in a similar fashion, moves away from its baseline.

A histogram usually accompanies the MACD indicator to disclose the difference between MACD and the 9-day EMA line. The histogram is essential for traders in that they can identify bearish or bullish conditions in the market.

For example, when the histogram is positive (lies above the 0-midpoint), but then begins to fall towards the midpoint. Such a situation alludes to a declining uptrend.

2.      Relative strength indicator (RSI)

The RSI is another popular trading indicator in constant use today, more so in the day trading arena. As a part of the New Systems in Trading book by J. Welles Wilder, RSI indicates the momentum a trading instrument bears.

To do so, RSI takes into account the price of a commodity or stock and follows its upward and downward trend. How fast this rate fluctuates is indicative of the strength of its price action and, as such, may give you a bearing as to the direction the market follows.

While using an RSI, stocks are given a value between 0-100 and then compared against other parameters such as under bought or overbought values.

RSI often uses the values 70 and 30 as caution points. They indicate both overbought and oversold assets, respectively, and can even be reconfigured to suit the trader’s preference. For instance, you can set them to 80 and 20 to ascertain the trading decision and avoid hasty moves.

Its use by day traders is well-known and hence is charted following daily trading intervals. Nevertheless, shorter time frames are used to chart RSI when you are scalping.

3.      Average directional index (ADX)

The ADX was designed as part of the Directional Movement System in conjunction with Minus Directional Indicator (DMI-) and the Plus Directional Indicator (DMI+).

Directional Movement Systems are meant to assist in measuring momentum as well as the direction a price is moving to. ADX is, however, derived from the aforementioned –DMI and +DMI. The pair are obtained after comparing two consecutive bottoms and high points.

When the ADX value goes above 25, it indicates a strong trend and none when it drops to below 20. If the ADX is falling from a high position, then the prevailing trend is coming to an end or weakening when the decline is sustained.

A rising ADX signifies an improving trend. When it increases by 4-5 units, then you can ride on the pattern to some meaningful gains. As the ADX line is related to the accelerating price movement, it tends to flatten when this trend indicator follows a constant slope.

Advantages of using momentum indicators

Momentum indicators are used to show the strength of price movements. Basically, if a robust upward trend up should hold out for even longer than another with weak tendencies. The former holds better investment opportunities for traders.

Additionally, these indicators pick out market reversal points. Through either bearish or bullish divergences, you will get a pretty good feel as to the interest that drives the price of a stock. The points between momentum and price movement are especially critical to recognizing market reversal points.

Nevertheless, momentum indicators are rarely used in isolation, and most times, do not serve as primary indicators. They indicate the strength of a trend but not where this trend is headed.

You will not get the direction of price movement from momentum indicators alone hence the need to combine other technical indicators to your trading strategy. Momentum indicators serve best as confirmatory tools complementing other indicators that signal the direction of price/ action.

Day-traders are generally involved in making rapid trades throughout the day, and rarely will they hold a position throughout the night.

Moreover, these guys train their focus on the varying price trends throughout the day. As such, a keen emphasis is placed on technical information about the price of trading items and commodities. This technical information, in a broad sense, refers to the numbers that explain price movement.

To better get a picture of price movements, day traders often employ technical indicators to guide them in tracking buy and sell points. Consequently, day traders are reliant on technical indicators for them to trade.

What is a technical indicator?

In a broad sense, a technical indicator will show you when the time is right to trade. These trading tools provide valuable signals which traders use to make trading decisions.

Any technical indicator is the result of technical analysis of available data. To properly appreciate indicators in trading, you must understand the significance of conducting technical reviews and the role it plays in coming up with technical analysis tools.

Technical analysis

Developed by Charles Dow in the Dow Theory, technical analysis assumes that information on previous trading activity and price movements are indicative of future behavior of the same parameters. Over the years, trading charts have shown how various market patterns are periodically recurrent over time. History repeats itself, following how little human trading psychology has changed.

Trading is affected by the forces of demand and supply. These are further affected by a broader range of factors such as commodity price, politics, volume, substitute items, and so on.

Of great importance in this instance are the commodity price and volume. This is what traders are interested in when analyzing the market conditions. For day traders, the actual commodity price combines all the factors that affect supply and demand and hence forms a vital part of trading.

Price action is what determines whether day traders will buy or sell. If the price of an instrument falls, you buy and later sell when the same appreciates. Doing this will ensure you earn a profit.

For day traders, the primary factor affecting their readiness to trade is the prevailing price of any commodity or trading option and volume traded.

To conduct a technical analysis, traders consider available data and trends in the market. Price movement and trade volume are essential items usually indicative of the general market environment. These often give pointers on the general direction traders should follow derived from the projected variation in price and volume.

When conducting a technical analysis, the main goal is to obtain trading signals for short-term trading periods, hence why it is crucial among day traders. Moreover, this scrutiny helps traders examine how strong an instrument performs on the market or its weakness. This information then goes a long way in improving a trader’s conviction in a trade.

So once you have sorted the analysis bit, technical indicators are much easier to work with.

Classes Of Technical Indicators

1.      Trend Indicators

As the name implies, trend-following indicators attempt to figure out the general trend in a market. While traders are often capable of identifying a pattern just by looking at the price chart, recognizing a trend during its formative period is often harder.

2.      Momentum Indicators

Momentum measures how fast the price of trading instruments change. In John J. Murphy’s book, ‘Technical Analysis of the Financial Markets,’ he explains, ‘Market momentum is measured by continually taking price differences for a fixed time interval. To construct a 10-day momentum line, simply subtract the closing price ten days ago from the last closing price. The positive or negative value is then plotted around a zero line.”

By measuring the strength of rising prices, momentum indicators point to the sustainability of price action and, consequently, the viability of investing in the same. This way, the indicators signal when conditions for buying or selling are ripe. This may happen when either overbought or oversold situations are witnessed in the market.

3.      Volatility Indicators

Volatility measures how commodity prices adjust throughout a trading period. To do this, traders consider the shifting values of trading options during the period to conclude how volatile a stock is.

A significant price range means a highly volatile commodity. The opposite holds for a smaller price range. To get the price range, simply get the difference between the highest and lowest price for that day.

Volatility indicators, therefore, point out the volatile behavior of an instrument’s price and assist traders in evaluating trading decisions.

Best Indicators For Day Trading

Day traders combine a wide range of indicators while studying trading charts. The most common ones used are:

a.       RSI

RSI indicates a stock’s momentum following the rate at which the price appreciates or depreciates. Naturally, the value assigned to any trading instrument experiences periodic rise and fall. Keen interest is placed on how fast the trend appears and disappears and hence draw attention to the strength of the commodity price. Knowing how the market behaves often gives you a leg-up when it comes to predicting market behavior. RSI enables day traders to monitor market dynamics via price momentum. As such, you will be able to distinguish bullish or bearish market signals and know precisely when to trade.

b.       Bollinger Bands

These bands are a popular feature on different price charts. While based on a rather simple moving average, Bollinger bands identify market volatility in the present. The bands are made of three lines, a middle moving average and two standard deviations on either side.

The bands deviate from one another by increasing the space between each band. This is known as expansion and it increases when the market volatility is on the rise. On the contrary, the bands will contract when the market volatility diminishes.

c.       Commodity Channel Index – CCI

Established in the eighties, CCI compares the current option price to the average running for a specific period. Additionally, this indicator oscillates above and below the zero – line.

This index, unlike its name, is not designated for the commodities market but cuts across various financial sectors. Day traders mainly apply the indicator on short period charts. When the CCI increases, traders receive more trading signals as opposed to a longer-term application of the tool. For day traders, they don’t make indicators as good as this one.

A large number (75%) of CCI values fall between -100 and +100. Other values that lie above this range are indicative of a very strong price-change concerning the average price.

d.       Average Directional Movement Index – ADX

ADX is a trend-following indicator made up of three lines, namely ADX line, +DI line and –D line. The ADX line is used to determine how strong a trend is. The remaining lines thus assess the direction of the same pattern and will indicate an upward trend or the reverse of it.

Once the –D line crosses the +D line, the market is experiencing a downward trend. When the positions of the D lines are interchanged, then the market is experiencing an upward trend.

e.        Stochastics

As is the case with the RSI indicator, the Stochastics indicator is also an oscillator. It compares the actual price if a trading instrument to a range of prices. This comparison spans a specific time.

The similarity with RSI doesn’t stop at their makeup, but also the interpretation employed with Stochastics. Traders are typically on the lookout for oversold or overbought levels in the market and these points determine whether they will trade.

While the RSI scale is set at 70 to indicate overbought levels, the Stochastics position reaches 80 and falls to 20 for oversold conditions.

Typically, oscillators operate poorly when markets start to trend. As such, you are advised to ignore signals that these indicators provide, as some of them may be misleading.

f.       Fibonacci

Unlike most of these indicators, Fibonacci is not as popular. However, it is still a standout indicator used for day trading. The Fibonacci indicator makes use of the Fibonacci sequence of numbers. In this sequence, every digit is the total sum of the previous two numbers. Also, every consecutive pair gives a ratio that is constant across the series.

The Golden ratio is not just a marvel of arithmetic but is functional in the Fibonacci tool. Here, it aids in finding possible retracement levels in a trending market.

g.       Average True Range Indicator

ATR measures volatility in the financial market. Volatility stems from the range of a stock price after considering the highest and lowest prices. With this range, we can, therefore, understand how volatile the commodity price is from the volatility. A highly volatile market means that prices fluctuate to a more considerable extent as compared to one with low volatility.

In trading, history tends to repeat itself even on the market floor. A period of low volatility is usually followed by a highly volatile one and vice versa. In between the different periods is a breakpoint. It is at this position that traders choose to trade as a result of changes in the price trend.

For day traders, the ATR serves an essential role in mitigating losses from a trade that isn’t performing. The indicator helps traders identify where to position their trailing stop loss.

For newbie traders, using these indicators may sound complicated in the initial stages. However, once you get started creating trading charts, everything falls into place.

For instance, chart makers like TradingView offer a pretty simple way to incorporate indicators into your chart. What’s more, you have a wide selection of indicators and their strategies to choose from.

While trading, price changes are the key points that determine the profit or loss any trade is posited to achieve. Therefore, traders are keen on the factors that affect price changes and, where possible, predict these situations.

One such tool that traders employ when figuring out changes in price is the Relative Strength Index or RSI. J. Welles Wilder developed the Relative Strength Index  indicator in his classic hit, ‘New Concepts in Trading Systems.’

Today, the index serves traders who leverage it when analyzing a stock chart and can add great value to any trading strategy. Read on to find out how you can employ this tried and tested tool and succeed in your trades.

What Is RSI And The Role It Plays In Technical Analysis

RSI is a tool used in technical analysis to indicate a stock’s momentum. A stock price usually follows a particular trend where it will experience periodic rise and fall. The momentum, therefore, is how fast the price appreciates or depreciates over time.

Throughout the history of trading, great importance is heaped on technical analysis. Through it, traders have been able to study previously recorded data, compare and contrast with the present, and make a prediction on what will happen in the future. Trading is all about foretelling what might happen so that as you invest your money, you will be confident of the returns.

Historically, markets across the globe witness more instances of growth more frequently as opposed to a downward movement. This trend has proved the importance of monitoring price momentum, more so when focusing on rising markets.

The speed at which the value of a stock goes up is a critical indicator of the strength of its price. As a trader, you need to gauge the prospects of an upward trend in the price of a stock. The RSI indicator provides suitable signals on bullish or bearish momentum in the price. The momentum, therefore, provides an appropriate reference point when analyzing data on the price of a stock or commodity.

While trading, frequent market assessment is crucial. Things move fast across global markets, and to be in business, you ought to be in the know every day. Relative Strength Index indicator is often employed in technical analysis to give you vital information on how the market behaves.

Armed with this data, you will then have a better understanding of the general market environment. Furthermore, knowledge of the market’s behavior should assist you in identifying the best possible investment opportunity to invest.

Unique Features Found In RSI

The RSI formula is capable of assessing price momentum and, as such, is a favorite among technical analysis traders. It has a couple of unique features that allow it to work so well to identify overbought or oversold conditions in the market.

1.      Oscillation

Traditionally, the RSI indicator is classified as an oscillator indicator. We draw this depiction from oscillators which follow a band but deviate periodically within the band. This deviation may usually occur between pre-defined points or above and below a centerline.

RSI is typically set to move within 0-100 as it indicates overbought or oversold market conditions. Above 70, an overbought market is happening or occurred, and the opposite holds when the figure falls to 30 or below.

2.      Centerline crossover

There are two types of centerline crossover; a rising centerline crossover and a falling centerline crossover. Centerline crossovers are necessary market signals indicative of either bullish or bearish market development.

In the case of a rising centerline, the RSI value crosses the 50 line as it nears the 70 line on the scale. Beyond this, market conditions are point to an overbought scenario. On the other hand, a falling centerline crossover lies below the 50 line but only until it reaches the 30 mark. As it moves beyond the 30 line, an oversold condition is the main takeaway.

3.      Relative Strength Index Divergence

This occurs between the Relative Strength Index and the price of the trading option. Such a movement indicates that a reversal of market conditions is about to take place.

The two primary types of divergence are Bearish and Bullish divergence. In the former, the price attains a new high as RSI stands at a much more diminished high point. As such, traders use it as a sell sign. The reverse happens when the price falls to a new lower level but RSI maintains a slightly higher low level. As such, the latter urges traders to buy.

4.      Positive-negative reversals

Positive-negative reversals differ completely with Relative Strength Index divergence and, as you will see, are the exact opposite of the latter.

A positive reversal points to a sustained increase in the price of a commodity. This will appear where the trading item attains a higher low, so to speak, and RSI realizes a much ‘lower low.’ This lower figure lies between 30-50.

The negative reversal on the other hand, operates in defiance of positive reversals. An instrument will attain a weakened high level as the RSI climbs to a much more significant position. This ‘higher high’ falls between 50-70 lines. Notice that the negative reversal doesn’t crossover to overbought territory. Contrary to a positive reversal, negative reversal indicates a continued decrease in the price of an option.

Generally, price reversals exhibit, once the price performs better than momentum and this feature is seen in specific trends. Traders can then utilize them to confirm a trend.

Why Traders Opt To Use RSI

RSI indicator is a trade favorite among traders, more so technical analysis traders. Most do not use it as a standalone indicator but rather combine it to form part of a greater trading strategy, and here is why:

1.      RSI recognizes overbought and oversold market conditions

Like the Stochastic indicator, Relative Strength Index can be used to point out highs and lows depending on whether the market is overbought or oversold. Such parameters are essential when you want to know when the price will likely go up or fall.

The Relative Strength Index scale runs from 0-100. An overbought market is indicated by readings of 70 and above, while an oversold one will entail readings at 30 or lower. When the market is oversold, traders interpret this to point to a likelihood of the price strengthening. With oversold conditions, you are presented with an opportunity to buy into the market as the declining trend is likely to reverse.

During overbought situations, the probability of currency prices to fall is high, and hence the inclination to sell on this signal.

2.      Traders use it to locate centerline crossovers

Locating the centerlines is a crucial step to figure out the general trend. Any movement originating from below the centerline (50) upwards shows that the trend is on an upward trajectory, and its strength is similarly on the rise. This is often considered a bullish signal only until it reaches the 70 line. On the other hand, a falling trend follows a movement from beyond the 50-line heading down until 30.

3.      Verifies the formation of trends

One of the reasons RSI is popular is because it confirms trend formations in trading prices. For starters, one needs first to ascertain the position of Relative Strength Index. Does it lie above or below the 50 mark?

Typically, there may be an early indication of a downward trend forming. However, you should first wait until the index crosses the halfway point to confirm the trend. The reverse holds for the formation of an upward moving trend.

Limitations Of RSI

 Relative Strength Index primarily indicates momentum and can stay in overbought or oversold conditions for extended periods. This may occur when the asset in question has a significant movement in a specific direction. As such, RSI would need a market that fluctuates periodically between bullish and bearish situations. When such a market indicates a strengthening trend, the RSI then loses its usefulness.

Technical analysis tools like Relative Strength Indexrely greatly on available data to give trading signals more so when considering long-term moves. These signals are therefore relied upon when they match a long-term trend in the market. Moreover, the RSI formula uses 14 periods as standard so it would not favor day traders.

False reversal signals come as frequently and can sometimes be difficult to distinguish from accurate signals. For instance, a bullish crossover resulting in a declining stock is a false positive.

The Takeaway

The Relative Strength Index indicator is a powerful technical analysis tool that traders can utilize to aid their trades. While it is not the single best indicator you can find, the mechanisms surrounding RSI are potent and feature prominently among technical analysis traders.

For newbie traders, it seems instinctive to quickly jump onto the Relative Strength Index trading bandwagon before adequately understanding how to interpret an indicator correctly. Remember, the RSI might throw a false positive and mislead your trade. Therefore, patience is essential as you should first have a thorough understanding of such technical analysis tools.

 Relative Strength Index, once understood, has the potential to provide you with signals for when the market is ripe for trade. By signaling overbought or oversold conditions, traders will be able to gauge the general market environment allowing them to understand the strength of the price movement to consider trading for the long-term.

Nevertheless, Relative Strength Index should not be your sole indicator but rather complement your existing trading strategy. Traders, more so beginners should first run RSI strategies on a demo account before getting the real experience on a live account.   

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