Moving averages, RSI and volume
Indicators sum up price and volume in lines that are easier to read. The three most used and how to interpret them without becoming their slave.
A technical indicator is a calculation made with price or volume, shown on the chart to sum something up: the trend, the strength of the move or investors' interest. There are hundreds; these three are the most common and enough for most people.
Moving averages
A moving average is the average closing price of the last N days, recalculated every day. It smooths the noise and shows the underlying direction. The most watched are the 50-day (medium term) and the 200-day (long term).
- Price above its 200-day average: usually read as a bullish underlying trend.
- Price below its 200-day average: a bearish underlying trend.
- Golden cross: the 50-day crosses above the 200-day; associated with strength.
- Death cross: the 50-day crosses below the 200-day; associated with weakness.
Simple averages weight every day equally; exponential ones give more weight to recent days and react faster. Since they're averages of the past, they always lag the price a little.
RSI (relative strength index)
The RSI measures, on a 0-to-100 scale, how strong the gains have been compared with the losses over recent days (usually 14). It's interpreted like this:
| RSI | Common reading | Caution |
|---|---|---|
| Above 70 | "Overbought": it rose a lot, fast | In strong trends it can stay above 70 for a long time |
| Between 30 and 70 | Neutral zone | — |
| Below 30 | "Oversold": it fell a lot, fast | A falling stock can keep falling with a low RSI |
A finer signal is divergence: if the price makes a higher high but the RSI makes a lower high, the rally's strength is fading.
Volume
Volume is how many shares traded in the period. It confirms moves: a rally or breakout on high volume shows broad participation; one on low volume, little conviction.
Others you'll see
- MACD: the difference between two exponential averages; its crossovers are used as momentum-change signals.
- Bollinger Bands: an average with two bands that widen and narrow with volatility.
- ATR: the average daily range of movement; it helps measure volatility and set reasonable stops.
How to use them sensibly
- Use few and understand what each measures; many indicators say the same thing.
- Look for confirmation: trend, level and volume pointing the same way.
- Fit them to your horizon: the settings for a 5-minute chart don't work for investing over years.
- Remember they all come from past prices.
Test what you learned
1. What is the "golden cross"?
- The 50-day average crosses above the 200-day
- RSI reaches 100
- The price hits its high
Show the answer
The 50-day average crosses above the 200-day. It's associated with medium- and long-term strength.
2. What does an RSI below 30 indicate?
- Oversold: it fell a lot, fast
- The company went bankrupt
- Overbought
Show the answer
Oversold: it fell a lot, fast. Though it can keep falling if the trend is strong.
3. Why does volume matter in a breakout?
- It doesn't
- High volume shows more participation and backing
- Low volume shows more strength
Show the answer
High volume shows more participation and backing. A breakout without volume is more likely to fail.
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Everything in this section is educational: it explains how investing works, it doesn't tell you what to buy.