To find the best technical indicators for your particular day-trading approach, test out a bunch of them singly and then in combination. You may end up sticking with, say, four that are evergreen, or you may switch off, depending on the asset you're trading or the market conditions of the day.
Regardless of whether you're day-trading stocks, forex, or futures, it's often best to keep it simple when it comes to technical indicators. Here are some of the most popular technical indicators you can use to start improving your trades.
Relative Strength Index
The relative strength index (RSI) can suggest overbought or oversold conditions by measuring the price momentum of an asset. The indicator was created by J. Welles Wilder Jr., who suggested that the momentum reaching 30 (on a scale of zero to 100) was a sign of an asset being oversold—and so a buying opportunity—and a 70% level was a sign of an asset being overbought—and so a selling or short-selling opportunity. Constance Brown, CMT, refined the use of the index and said the oversold level in an upward-trending market was actually much higher than 30 and the overbought level in a downward-trending market was much lower than 70.
Using Wilder's levels, the asset price can continue to trend higher for some time while the RSI is indicating overbought, and vice versa. For that reason, RSI is best followed only when its signal conforms to the price trend: For example, look for bearish momentum signals when the price trend is bearish, and ignore those signals when the price trend is bullish.
Moving Average Convergence/Divergence (MACD)
To more easily recognize those price trends, you can use the moving average convergence/divergence (MACD) indicator. MACD consists of two chart lines. The MACD line is created by subtracting a 26-period exponential moving average (EMA) from a 12-period EMA. An EMA is the average price of an asset over a period of time, only with the key difference that the most recent prices are given greater weighting than prices farther out.
The second line is the signal line and is a nine-period EMA. A bearish trend is signaled when the MACD line crosses below the signal line; a bullish trend is signaled when the MACD line crosses above the signal line.
Other Technical Indicators
Of course, you're not limited to RSI and MACD. Other technical indicators can help give useful insight into market movements and price trends as well.
Bollinger bands are a lagging indicator that can help you determine whether prices are relatively high or low, and can be useful for gaining insights on volatility. A middle line or "band" is determined, often by using the 20-day simple moving average (SMA). The top line is determined by adding twice the daily standard deviation to the middle band. The bottom line is found by subtracting twice the daily standard deviation.
The band formed by these calculations can be used to indicate overbought or oversold levels, and it can inform a trader as to a trending price envelope.
Exponential Moving Average
Like the simple moving average, the exponential moving average (EMA) is a lagging indicator that can be used to find trends over time. However, the exponential moving average is calculated to give more weight to current trends, whereas the SMA finds the average using equally weighted data.
Using the EMA may let you find trends earlier than the SMA because it's more sensitive to recent price changes.
The stochastic oscillator is a momentum indicator based on closing-price trends. Developed in the 1950s by George Lane, it can be used to find overbought and oversold levels.
It is a range-bound indicator, with 0 at the base and 100 at the top. Using that range, you can find sell signals when the line crosses from above to below the 80 level, and buy signals when it crosses from below to above the 20 level.
Fibonacci retracements are a leading indicator that uses Fibonacci numbers to identify particular areas of price support or resistance along a line between a low price and a high price: 0%, 23.6%, 38.2%, 50%, 61.8%, and 100% of the trend line. These percentages can then be applied to the difference between the low and high prices for the period delineated.
Fibonacci retracement levels can give an indication of areas where prices might see a reversal, retracing a previous trend.
Consider pairing up sets of two indicators on your price chart to help identify points to initiate and get out of a trade. For example, RSI and moving average convergence/divergence can be combined on the screen to suggest and reinforce a trading signal.
When selecting pairs, it's a good idea to choose one indicator that's considered a leading indicator (like RSI) and one that's a lagging indicator (like MACD). Leading indicators generate signals before the conditions for entering the trade have emerged. Lagging indicators generate signals after those conditions have appeared, so they can act as confirmation of leading indicators and can prevent you from trading on false signals.
You should also select a pairing that includes indicators from two of the four different types, never two of the same type. The four types are trend (like MACD), momentum (like RSI), volatility, and volume. As their names suggest, volatility indicators are based on volatility in the asset's price, and volume indicators are based on trading volumes of the asset. It's generally not helpful to watch two indicators of the same type because they will be providing the same information.
Using Multiple Indicators
You may also choose to have onscreen one indicator of each type, perhaps two of which are leading, and two of which are lagging. Multiple indicators can provide even more reinforcement of trading signals and can increase your chances of weeding out false signals.
Whatever indicators you chart, be sure to analyze them and take notes on their effectiveness over time. Ask yourself: What are an indicator's drawbacks? Does it produce many false signals? Does it fail to signal, resulting in missed opportunities? Does it signal too early (more likely for a leading indicator) or too late (more likely for a lagging one)?
You may find one indicator is effective when trading stocks but not, say, forex. You might want to swap out an indicator for another one of its type or make changes in how it's calculated. Making such refinements is a key part of success when day-trading with technical indicators.
You can also customize the indicators you choose. For instance, you can modify the numbers used in a Fibonacci retracement and choose to set the top line at, say, 78.6% instead of 61.8%. If such modifications help you identify price movements, then it's worth experimenting.
Using technical indicators in trading can really be more of an art than a science. You need to be ready and willing to tweak indicators to match what works best for you and gives you the results you're looking for.