Best Technical Indicators for Day Trading

With loads of technical indicators, here's how to narrow it down to a few.

best-technical-indicator-for-day-trading.jpg
da-kuk, Getty Images

The MACD, RSI, moving average, Bollinger Bands, stochastics, and the list goes on, but what are the best technical indicators for day trading? Day traders need to act quickly, so trying to monitor too many indicators becomes time consuming, counter productive and is actually likely to deteriorate performance. When day trading--whether stocks, forex or futures--keep it simple. Use only a couple indicators, maximum, or not using any is fine too.

Consider these tips to find the best day trading indicator(s) for you.

Day Trading with Indicators or No Indicators

Indicators are just manipulations of price data or volume data, therefore many day traders don't use indicators at all. Indicators aren't required for profitable trading. Practice trading based on price action and there is little need for indicators. That said, an indicator does help some people see things that may not be obvious on the price chart. For example, the price is trending higher, but it is losing momentum. To someone not used to reading price action (analyzing how the price is moving) this may be hard to see, but indicators can make it more obvious. Unfortunately, indicators come with their own sets of problems, signaling a reversal too soon or too late (see Don't Trade MACD Divergence Until You Read This).

Indicators aren't inherently bad or good, they are just a tool and therefore whether they are detrimental or helpful depends on how they are used.

Many Trading Indicators are Redundant

Many indicators are almost exactly the same, with slight variations. One may be based on percent movements while another is based on dollar movement (PPO and MACD). Also, indicators may be part of the same "family." Examples of this include the MACD, stochastics and RSI.

While they may appear slightly different, usually just using one is enough. Having all three on your chart isn't going to improve the odds of your trades, because all these indicators are going to give you pretty much the same information most of the time. 

Even a moving average (MA) and a MACD can give the same information. If you use a MACD (12,26) indicator and also add 12 and 26-period MAs to your price chart, the MACD indicator and MAs will tell you the same thing. In fact, all the MACD does is show how far the 12-period moving average is above or below the 26 period moving average. When the MACD crosses above or below the zero the line, that means the 12-period moving average crossed above or below the 26-period. If you added these indicators to your chart they would always confirm each other, because they are using the same input. 

If you opt to use indicators, only pick one from each of the following four groups (if required, remember indicators aren't need to trade profitably). Even picking only one from each group could lead to redundancies and clutter, without providing additional insight.

  • Oscillators: This is a group of indicators that flow up and down, often between upper and lower bounds. Popular oscillators include the RSI, Stochastics, Commodity Channel Index (CCI) and MACD.
  • Volume: Aside from basic volume, there are also volume indicators. These typically combine volume with price data in an attempt to determine how strong a price trend is. Popular volume indicators include Volume (plain), Chaikin Money Flow, On Balance Volume and Money Flow.
  • Overlays: These are indicators that overlap the price movement, unlike a MACD indicator for instance which is separate from the price chart. With overlays you may choose to use more than one, since their functions are so varied. Popular overlays include Bollinger Bands, Keltner Channels, Parabolic SAR, Moving Averages, Pivot Points and Fibonacci Extensions and Retracements.
  • Breadth Indicators: This group includes any indicators that has to do with trader sentiment or what the broader market is doing. These are mostly stock market related, and include Trin, Ticks, Tiki and the Advance-Decline Line.

    There is little need for more than one oscillator, breadth or volume indicator. You may find uses for a few overlays though, helping to indicate trend changes, trade levels and areas of potential support or resistance. Master using price action and overlays and you likely won't have need for the other types of indicators.

    Combining Day Trading Indicators

    Consider picking picking one or two indicators to help with entries and exits, respectively. For example, an RSI could be used to help isolate the trend and entry points. In an uptrend, the RSI should be extending above 70 on rallies and staying above 30 on pullbacks. This simple guide can help confirm the trend, highlight trading opportunities, and see when the market may be changing trend direction.

    A moving average, ATR Stops (Chandelier Exits) or Moving Average Envelopes could then be applied to the chart (overlays) to aid in exits. For example, one of these could be used as a trailing stock loss on trending trades. If the trend is up, look to exit if the price falls below the line (which will be below the price as the price rises).

    This is just one example of how indicators can be combined. Which indicators are chosen depends on how a trader trades, and on what time frame. Calibrate each indicator (via the indicator settings) to the specific assets, time frame and strategy being traded. Default setting on the indicator may not be ideal, so alter them to make sure they give the best signals for the trades being taken. Indicator settings may require adjustments occasionally as market conditions change over time.

    Final Word On the Best Indicator for Day Trading

    Unfortunately, there is no single indicator that is the best for day trading. Technical indicators are just tools, they can't produce profits. Profits require a trader to use their indicators and price analysis skills in the correct way (see Day trading False Breakouts). This takes practice. Whatever indicators you decide to use, limit it to one to three (or even zero is fine). Using more indicators is redundant and could actually lead to worse performance.

    Know your indicator(s) well: What are its drawbacks? When does it typically produce false signals? What good trades does it miss (failure to signal)? Does it tend to give signals too early or too late? Can the indicator be used to trigger a trade, or does it just alert you too a potential trade (good timing or poor timing)?

    Know those things about the indicators you use, and you will be on your way to using it more productively.