In a perfect world, we could take just one of these indicators and trade strictly by what that indicator told us. The problem is that we DON’T live in a perfect world, and each of these indicators has imperfections. That is why many traders combine different indicators together so that they can “screen” each other. They might have 3 different indicators and they won’t trade unless all 3 indicators give them the same answer. 

As you continue your journey as a trader, you will discover what indicators work best for you.  We can tell you that we like using MACD, Stochastics, and RSI, but you might have a different preference.  Every trader out there has tried to find the “magic combination” of indicators that will always give them the right signals, but the truth is that there is no such thing. 

We urge you to study each indicator on its own until you know EXACTLY how it reacts to price movement, and then come up with your own combination that fits your trading style. Later on in the course, we will show you a system that combines different indicators to give you an idea of how they can compliment each other.

Everything you learn about trading is like a tool that is being added to your trader’s toolbox.  Your tools will make it easier for you to “build” your trading account. 

Bollinger Bands

• Used to measure the market’s volatility
• They act like mini support and resistance levels
• Bollinger Bounce
  • A strategy that relies on the notion that price tends to always return to the middle of the Bollinger Bands
  • You buy when the price hits the lower Bollinger band
  • You sell when the price hits the upper Bollinger band
  • Best used in ranging markets
• Bollinger Squeeze
  • A strategy that is used to catch breakouts early
  • When the Bollinger bands “squeeze” the price, it means that the market is very quiet, and a breakout is eminent.  Once a breakout occurs, we enter a trade on whatever side the price made its breakout. 

MACD

• Used to catch trends early and can also help us spot trend reversals
• It consists of 2 moving averages (1 fast, 1 slow) and vertical lines called a histogram, which measures the distance between the 2 moving averages.
• Contrary to what many people think, the moving average lines are NOT moving averages of the price.  They are moving averages of other moving averages.
• MACD’s downfall is its lag because it uses so many moving averages. 
• One way to use MACD is to wait for the fast line to “cross over” or “cross under” the slow line and enter the trade accordingly because it signals a new trend.

Parabolic SAR

• This indicator is made to spot trend reversals; hence the name Parabolic Stop And Reversal (SAR)
• This is the easiest indicator to interpret because it only gives bullish and bearish signals. 
• When the dots are above the candles, it is a sell signal.
• When the dots are below the candles, it is a buy signal.
• These are best used in trending markets that consist of long rallies and downturns.

Stochastics

• Used to indicate overbought and oversold conditions
• When the moving average lines are above 70, it means that the market is overbought and we should look to sell.
• When the moving average lines are below 30, it means that the market is oversold and we should look to buy.

Relative Strength Index (RSI)

• Similar to stochastics in that it indicates overbought and oversold conditions.
• When RSI is above 80, it means that the market is overbought and we should look to sell.
• When RSI is below 20, it means that the market is oversold and we should look to buy.
• RSI can also be used to confirm trend formations.  If you think a trend is forming, wait for RSI to go above or below 50 (depending on if you’re looking at an uptrend or downtrend) before you enter a trade.

Each indicator has its imperfections.  This is why traders combine many different indicators to “screen” each other.  As you progress through your trading career, you will learn which indicators you like the best and can combine them in a way that fits your trading style.

We know this has been a very loooooooooooonnnnng lesson, and we do encourage you to go back and read over anything you haven’t fully understood yet.  Sometimes it just takes a couple times of reading before you truly grasp something. 

Once you understand the concepts of these indicators, go to a chart and start playing with them.  Really study how each indicator reacts to the price movement. 

When you fully understand an indicator, then it will become another tool for your trader’s toolbox.  For now you should just take a break.  Grab some coffee or get something to eat.  We know your eyes are hurting!  Let this lesson soak in, and then come back when you’re refreshed!

Extra Credit!

Use Bollinger Bands as S&R Levels and Trade Breakouts
Learn this simple technique to trade breakouts by using Bollinger Bands as dynamic support and resistance levels.