In addition to using "candlestick formations", time frames, and studying patterns in price graphs. Investors whom do TA use technical indicators. Here we have an endless amount of indicators that can be used in different ways, depending on which strategy you intend to use. These indicators help create an "image" of how the technical "setup" is for the current instrument. Traders and investors tend to have certain technical criteria that must be met before the instrument is investable.
Since there are so many different technical indicators, they can quickly create more "noise" than the utility. It is therefore important that you find out which indicators suit you, your model, and your investment strategy the best.
Moving averages (MA)
The most commonly used technical indicators are called "Moving averages" or MA. Many trading strategies use one or more of these MAs. A "moving average" is an indicator that creates a line in the chart that is defined by a specific time period.
The most commonly used are 21-day, 50-day, 100-day, 150-day, and 200-day moving averages. These lines can then be used to show, for example, whether an instrument has an upward or downward trend. They can also be used to display technical "supports" or "resistances" for an instrument. There are countless ways to use the various MAs, and strategies that address some of them can be found here.
Below is a chart/price graph with different types of MAs:
As you can see from the image above, MAs can be used in many ways. We see that they have proven to be good "supports" during a solid uptrend, and give an indication when a trend is on the way to an end if price breaks through the lines.
We also have different types of "Moving averages". These are called SMA and EMA.
Stands for "Simple moving average". This indicator ads a given period's daily (or other time frames) closing prices of a relevant instrument. The number you get from this period is thus divided by the number of days in the given period to create a new average for each day that is displayed as a line in the chart.
An example might be:
We have had the price for an instrument closing at = 5, 6, 7, 5, 8. These prices are thus summed = 31.
This number is divided by the number of days: 31/5 = 6.2, which becomes the SMA for a 5 day period. This calculation method is therefore used to define a line in the price graph, based on which time frame and how large a period one wishes to show in the chart (typically SMA 50, SMA 100, etc.).
The difference here is that the EMA places greater emphasis on the recent price movements for the instrument in question. This means that this indicator responds more quickly to price changes and can identify trends faster than SMA. You may then get "fake" trends and signals. EMA is usually used more by traders who want to have frequent entrances and exits.
Relative Strength Index (RSI)
We also have a widely used indicator called RSI (Relative Strength Index). This is a so-called "momentum indicator", which is used to check the extent of the recent price change in an instrument. It is then used to see if the instrument is "overbought" or "oversold".
The RSI is displayed as an oscillator, ie a line graph that moves between two endpoints (low and high). These points are set at 0 to 100, and most instruments move between 30-70 on the RSI scale.
The formula for how the RSI is calculated can be somewhat advanced, and you can read more about the calculation here.
As a basic explanation, the RSI will increase when the number and size of positive closes in an instrument increase, as well as fall if the opposite happens. You, therefore, get an indication of how strongly an instrument is trending up or down. It is usually calculated over a period of 14 days to smooth out the result.
Historically, an RSI indicator above 70 has been calculated as "overbought", while an RSI below 30 has been calculated as "oversold". It has later been shown that many instruments can often go well over 80 (and more) before they need a break. It may therefore be that you sell prematurely, and when the instrument is in a solid upward trend if you sell the instrument at an RSI = 70. The same can be said about trying to buy an instrument close to 30. It has also been shown here that instruments in downward trends often can continue further down even if they are close to "oversold" levels.
As you can see in the chart above, there are several points where the RSI is still "overbought" or "oversold", while the instrument only continues the trend in one of the directions. So there is something about the statement: "Follow the trend", or: "The trend is your friend". Do not sell or buy an instrument using only one indicator. A combination of indicators and patterns, as well as experience, should outweigh this decision. As you can see from the image, all instruments will at some point turn in the opposite direction of the trend when the RSI has become too "overbought" or "oversold".
In addition, RSI can be used for something called divergence. As you can see from the chart above, the RSI indicator rises while the price of the instrument keeps falling. In many cases, these are indications that the instrument is reversing the trend it is in. You can use divergence to look for bottoming signals in the instruments you are interested in buying.
As you can see, technical indicators can be used in a huge variety of ways during technical analysis. It is therefore important for you as an investor or trader to understand these, as well as find out which ones best suit your "style". Too many technical indicators can also create a lot of "noise" and too many signals. It is therefore important to read further, test, and find out which indicators you want to use. As mentioned above, you will find strategies that use some of these indicators and more here.
If you want to read more about technical indicators and several different types, you can follow these links:
technical indicators trading of indicators technical analysis technical indicators