Trading Indicators Explained - Basics of Stock Trading
Welcome back to another episode of the basics of trading featuring Prateek and me. In the previous episode we discussed support and resistance. What is Polarity? Chart patterns like double bottom and double top. Today we gonna level up and learn about indicators.
Indicators are quantified and they solve the problem of ambiguity. Hey Tanmay, what's up, wanna begin learning about indicators? Yes, let's do it. Okay, so the first thing we learned was price action. The price is moving, candlesticks, then we went to chart patterns, after we started learning there’s head and shoulder, which we didn't discuss, but we discussed, support and resistance which has some discretion.
Right, someone can draw the differently. Can be vague? Correct. Tanmay would draw the line differently, I would draw the line differently, so that's a problem there. Right. How do we get exact-ness when you're actually analyzing demand and supply.
Another way to do it is using indicators. Indicators basically are calculations on price, and is calculated by a charting platform. Got it. You don’t have to draw the lines. It comes calculated.
So, there is consistency. And it's quantified right, so thus everyone sees that indicator, exactly as it should be. Got it, got it.
So, the most popular indicator, it's called the moving average. Okay, what does that mean? It's an average. So let's take a simple analogy to understand this better. Let's suppose you are analyzing a class.
Okay. Class marks. Now let's suppose the average marks the entire class got was say 60 marks.
And then there is Chintu. Okay, who got slightly higher than everyone else, got it, and chintu let’s say at 75 marks. Now is he higher than the average? Yes.
Of course, yes. Let's take another example, why don't you give me another name. Prateek. Okay, so.
Below average. Prateek is sort of below average with 50 marks. Got it. Now the question is, in the next exam is Chintu likely to score better than Prateek? Likely.
Based on his previous performance. Correct, because last time, Prateek was below average, and Chintu was above average. Got it. Oh, that’s it, so moving average would be the average of the averages. So so moving average, actually, in stocks is very simple.
It's just the closing price of all the prices over a period of time. Got it. Right and why is it moving because every day the market opens, closes at different price, so you keep plotting that average every day and you draw a line through it, basically looks like this right so. So this is called Moving Average. People generally call it like MA for short right, so in charting platform so, MA, MA, that's what moving averages is. Where is the black marker? So, this will be price, what I'm going to draw.
So price will do this, will go up and will go down, will go down again it will go up, you'll have this movement that price is doing over a period of time. Now, what is the average of this, is what the moving average is. So the moving average would look something like this.
Correct. This is, it's sort of smoothens out pricing over a long period of time. Got it. Right.
Now how many days of average is it, is what is the, it's called period, what are the number of days you’re taking averages of, I can take averages every 50 days and plot them. Makes sense. Yeah, makes sense.
Yeah, so if I do say moving average 50, what does that mean? 50 days, yeah, price average. Correct. So the most popular one on a daily chart is the 200 day moving average, Okay, because it signifies, like a longer term.
So now you tell me. Let's suppose this is 200 day moving average, okay, I’ll rub this, let's suppose, this is 200 day moving average. Logically, if price is below the 200 day moving average.
What do you think that means? It's going to pick up, because the average is 200, so it's more likely to gravitate towards 200. Correct. So basically, and historically for the last 200 days, the average price has been this, so it's not going to deviate too far from it, it's likely to, yeah, the moving average is almost like a gravitational force of the stock.
It is actually, yeah you're totally right, so if it goes below it tends to come back, if it goes outside it tends to come back and you used a good word - deviate. How far is my price deviating from the average? It's a nice, nice to know things, you know. If your stock is gone too up, you’re like, this is gone really far from the historical average. It might take some breathe now. It did an Usian Bolt, now it needs to breathe.
And if it does this, then it will come back. Got it. And 200 day moving average is interesting, because if it goes higher than 200, what it means is this is more likely to be an anomaly because all the last 200 days it was here, no. Yeah. Then how suddenly it's going so high, and the way for the 200 day moving average to gradually go up, is for it to consistently go up over a long period of time, only then will the average shift.
Exactly. So if there is a spike for just 1-2 days, then it won’t affect moving average. But if there’s a continuous spike for 4 months, then moving average too will start moving. This is just like a batsman average.
Correct. Explain that a lil bit, what do you mean? If the batsman’s average for 5 years is 40, and if he wants to increase it to 50, then for the next 3 years, he has to have an average of 60, consistently. So that the average increases 40 to 50. Understood, it’s exactly like that. Right, so, basically there is lot of noise in the short-term.
Moving average smooths it out. So, this is the advantage you get from this. Again, it's not predicting where is it going, but like you said, shows deviation.
It makes the volatility feel less. Basically, by looking at moving averages you feel less scared of the volatility, as yes the stock is moving up and down in the short-term , but when you look at 200 days, then it’s actually quite fine. What did you say last time? All is well. So Tanmay, for moving average, do something for me, let's assume moving average is also acting like support. Let's assume that. Okay.
This is Avenue Supermarkets, also known as DMart. Let me zoom out a little bit. You can see price is going up and down, and the blue line in the middle is the average.
It's a 200 day moving average, how do you know, it’s written MA 200. So now, as you can see, price went up, came down. Do you notice something here? Can you just explain the story to me, of price and moving average. So, what happened was that, this is where it rallied right, because it rallied the moving average started going up, very slightly, very slightly, start going up slightly. Okay, and then it came down, again.
Hang on, hang on a minute. Came back to it's normal average and back to his normal average. Then it start to picking up again, it came here and then it actually, it broke support and went lower, so you see the moving average, all of a sudden plateaued, like it, like the trajectory, it was going like this, it became perfect, because it was sideways here for so long. So if the deviations is too far, would it be fair to say that the stock is currently slightly overvalued. Yes it is.
It also means the stock is in momentum. Yes, got it. Momentum holds for long and the moving average will change. Yes.
So the moving average will change but it take 200 days. Correct, that's a problem right. What is the stock management just went because they found this new product, new technology that changes the world. The moving average will have to wait 200 days to adjust.
That's a little late. Correct. Okay, what if you can change the moving average to a 50 day, or 60 day. Correct.
So that's one thing you can do, you can shorten the moving average. So we can actually do that, let me add a moving average, which is a say, moving average added, and I'll change this to 50. We can see that there's a shorter moving average over here in cyan, price went up, again it touched, notice that, went up again, okay interesting right. Whenever it, whenever the, whenever the candlesticks, break down of the moving average support, you see the trajectory of the moving average line just completely changes, it flattens out.
Yeah. Right, because it is trying to adjust to the new price. If a batsman suddenly maintains an average of 30 instead of 40, then his overall average will become 35n= instead of 40. That's what happens to this line as well. Correct.
Which is good, right. If you're seeing this from a longer term lens, you don't want the moving average to shift very quickly. Correct.
It will be a gradual curve. Consistency is important, if you’re performing consistently well, then I’ll believe you're a good stock. Got it. Let's see another thing. The first thing is you can shorten the moving average, we tried with 50.
There is something else called an EMA. What the EMA will do, it's just exactly like the MA, moving average, it's an exponential moving average. What it does is, it gives more weightage to the recent price action.
So, recent momentum is a factor. Correct. In determining the EMA. That's what is it EMA and it'ss a exponential moving average.
Okay what that will do is, it will give more weightage to the recent price movement. So if generally we've been moving up and suddenly there's a dip, it will give a little more weightage to the latest dip because hey, what's happening now is more important than what happened equiweighted over 200 days. Got it. So that's another thing you can do. So what I'll do is I'll add another EMA to show you what it looks like. So for a trader an EMA is more valuable than an MA.
Yes. Yeah, I would say so. Yes. It gives you an opportunity to understand if there's money to be made now.
Yes, in its current price movement. So, same thing, 200 day moving average. They’re both 200 days, the upper one is exponential, so it’s moving a little faster, but also telling you 200 days’ trend, so it's given the last few days, a little more weightage. If you see the stock has rallied, it's found a higher lows in the last, you know, in the last six months, how much is it, eight months. Correct. Yeah.
We can do is we can also change the color of the EMA so we can see it better, say green. So I can see that green better, with the exponential. Let me see if there's something else.
So, if you notice over here. If you notice over here, the blue line is taking its time and it's still plateaued. But the green line has dipped faster because that dip has come a little closer.
A little closer also it's seeing like a slight these last few months were slightly bearish for the stock. Yeah, so that's why short term bear bearish movement hasn’t impacted long term moving average much. Correct.
Got it. Another thing is, notice this rally here, that the markets have gone up right. The blue line is not, is not completely dramatically changing, but the green light has. The green line is giving a hockey stick vibe.
So that's basically an indicator. So now everyone knows where is moving average, there is no discretion, it’s calculated and everyone sees the same thing so that's an advantage. So when you making a system using an indicator is far more useful than a pattern. It gives you a little bit more story about what's really going on, and it's precise right? Yeah.
So yeah, Perfect. It like a opening a bonnet of car, and seeing what? And seeing if it’s properly working or not. Yeah, correct. That's exactly what it is. Okay, so one thing, pointing out the obvious here right, but let me remove the 200 day normal, average, and just keep the exponential, and I'll zoom out. Now the stocks, if you didn't get the higher swing low thing, then if a stock is consistently above this exponential 200 day, we assume it's in an uptrend.
Clearly uptrend here. And if the winds change, sort of the EMA will give you a clue. Let me change this to say something like say, Exide. In Exide, you can see your data. It's below Moving Average, so it’s a downtrend, clearly. So this is clear now. Tell me this, Exide’s market is falling continuously, this goes a little bit up and this like I say, 10% 20% rally, resistance, it start acting like, in a bearish market it starts acting as resistance.
Exactly. So now if someone asks you that Tanmay, Exide fell a lot, now it’s 20% higher, is this in uptrend? You’ll be like, it’s moving average hasn’t crossed resistance yet, it is still in downtrend. The 20% sounds good when you hear it, but the overall trend is still down. So this is very very useful for anyone right, to know where is the market going I know it's bearish right now.
Simple. Got it. So Tanmay, I have a question. What if I tell you there is a stock, with lots of momentum, and it's moved up really quickly over a few days long. What do you think is gonna happen next? It will come down because too many will have bought too much of it, so it will have to cool down a little bit.
Yes, so this is called overbought. When a stock has been bought too much and you're measuring it, if the momentum is high, it’ll sort of cool down a little bit. Correct. Okay, so we indicator which actually does this is the RSI. What does it stand for? The RSI, is Relative Strength Index.
Okay, it basically measures the strength of the stock, relative to itself, sort of whether or not you are as strong as before. This is an indicator of the inference we came to after seeing the first indicator. Yes, actually.
It's also called the RSI. And we always put a period right, how many days are we measuring, it's called the period. 14 RSI is the most popular. 14 days. 14 days, 14 Candles actually, but yeah 14 days.
So now let's understand what the RSI actually does. I won't get into the calculation bit, but I'll explain what it's calculating. Okay, so let's see we have candle one, candle two, candle three, candle four and candle five.
Okay. I think that's it. Now, let's make this green. This green.
This is also green, this iss also green. And we have one red candle, which is this. Now the RSI, It will find all the days it was up, so momentum gain gain gain, and then make a ratio of that gain with the down candle and see whether it was mostly up or down, and you will get a ratio which says the momentum was up, measure the open close open close open close open close, measure it versus the loss day, open, close, and make a ratio out of it. So, so far, the indicator that we discussed. Moving Average, it is on the price.
RSI is not on the price, it is under the price, and it's an oscillator. Okay, so it oscillates, that means moves between 100 and 0. There are 2 significant numbers here, one is 80 and the other is 20. Just draw this dotted line for 20. And this dotted line for 80. And now, in this case, the RSI will look something like this.
The moment the RSI goes above 80, we say that is overbought and it's likely to cool down. Right. And if the market comes down too much and it hits, it hits 20, we say okay it's oversold, and it's likely to come up. Ohh, this is like a proper indicator of what the real value of the stock is and whether you shouldn't buy or not. Yeah, it's very short term though, like because it's measuring momentum.
But for a trader that's really important. Yeah, it is, it is so maybe you might book your profits, if you're long on a stock at 80 in the RSI could be an exit indicator for you. Correct. You are an intraday trader and using it for your short term trades, like if it comes down to 80 I'll exit. So that's how you could use this tool to eventually make a system out of.
Got it, got it right. One problem though with the RSI and I'll say it right now is that the stock keeps going up, the indicator just sticks and stays there. So that's a problem.
But, I mean, every tool has its downsides. But this basically measures momentum, and then says our momentum is a bit tired and it will take a break. Okay Tanmay, so we have an example here. Let’s continue with Exide. So now, just notice two things, we have price going up and down.
And we also have moving average here, should I remove it, no it’s fine. We have RSI here. And there are dotted lines above RSI. Value above dotted line is 80+.
So if it moves above 80, then it means that the market is overbought, draw a line from here to here, look at that. Can you see that? So this part right, like you see here, it's like, way above 80. Yes, right, keep drawing.
There it is, perfect. Yeah. So you’ll notice, and you guys who’re watching this right you can do this on any chart. This went above 80, took some time, but then it eventually started to fall as it was overbought, and then it fell down. So the second on the RSI it goes below 20, it's likely to find some support and like we're likely to see a hammer there, like the demand. Nice, bringing things together now.
Yeah, so if it goes under 20 it's oversold. Yeah. You're likely, as you see the hammer stick go lower, you're likely to start seeing some demand there, nice and it can start you know you start seeing a lot of bullish engulfing patterns right after that. OHH dude this is just.
Then you still start seeing higher lows after that. I can't handle this. Then the stock will rally and, so proud.
And then when it reaches the top at resistance, you sell it, and then you're like, see, thank you for the profit from hammer to resistance. It can be double top too. Right, one question, here’s a dip, then market went up, here’s another dip, based on the RSI, will it go up? In the end, like right now the market is in the middle, So maybe it will just go, it’s very far from 20, right? It just broke its resistance, there will be new resistance and support. So, just based on the RSI tell me, is it near 20 or not? Yeah. It feels like it's fairly far from 20. Yeah, so it's not gonna bounce immediately.
Perfect. So another example we have, and this is Britannia, daily chart. Let's see, sideways, and the RSI is like roughly 40, pretty far from 20, it's not that far, it's further from 80 than it is from 20. Okay fine. Relative.
Markets falling, this is a big fall. Ohh, it's gone below 20. What does that mean? It means it's oversold. Which means? It's gonna rally back up. I mean it may rally but yes, yeah. Let's scroll up and see what happens.
And yeah, that's exactly what happened. This is also March 2020 so it's a pandemic. Pandemic, so tell me the pricing event from 2100 to? To 3600, Wow. It's like 70-80% at least right.
So that's interesting right. So RSI overall daily chart, especially in this really works, well. So this is how oversold works for RSI. Got it. It is important to know that whatever we've discussed right now, does not mean you should buy and sell based on this analysis. You're only getting a tool to understand where the market is, so don't actually make a decision based on this analysis yet.
Don't make any decision until you have a system. Yes. We should do something apart from just analysis right. We should. We should build like a system right.
On the next episode. Not yet, not yet. Let's learn a little more, but yes. The episode on the system is coming up next, soon. Coming up soon.
Cool. So what are you going to do next is, do a summary of what we did so far. Okay, so I'll ask you a bunch of questions and this is quiz time. Yes.
So if price is above moving average 200, what kind of trend does it mean? Price is above moving average 200, oh, it's an upward trend. Correct, and what's the downward trend? If it's moving below the MA. Perfect Yeah. Okay, fine, cool.
What's the difference between a moving average and an exponential moving average? Moving averages is of a particular time frame like 200 days etc-etc, and Exponential Moving Average, keeps the longer timeframe in mind, but also gives weightage to the short term moving average. Correct. So, if a stock has been steadily moving upward, but all of a sudden it takes a bullish turn, then the exponential moving average will reflect more of the bullish turm than the regular moving average. Correct, it will move little faster than the slower moving average.
Perfect. Excellent. What's my next question. Okay, let's talk about the RSI.
What's the full form of RSI? Relative strength, it's not written. It's actually. Relative strength index. Okay cool. And what does it measure? It measures the stock's current relative strength compared to itself. Okay.
All right. What this means is it's an indicator that tells you whether a stock is overbought or oversold, that's basically it. Alright and if it's above 80 it basically means? It's overbought and likely too likely to, you know cool off and come down a little bit. And the opposite is also correct. Excellent.
Cool. So I think that sounds good. Yeah.
We learned about price action, technical analysis basics. Yeah. But if we don't know how to place orders, we won’t be able to do anything. So take the table, bring the laptop. Okay, someone please give a laptop, connect the Internet, and we’ll place a few orders. Let’s start, let’s get into it.
Done, but next episode. You can check out the full course on LearnApp.com about RSI. Here we get a back tested system using the RSI indicator. Check out the link in the description and get two months of access for absolutely free. And while you trade, you can analyze your stock fundamentals and history in depth, all thanks to ticker tape, and before you begin trading one must have a D-mat account so open your own D-mat account. All of these links are available in the pinned comments so check it out.
In the next episode, you will learn.