📐 Module 6: Indicators

Moving Averages, MACD, RSI, Bollinger Bands, Stochastic, ATR

In this Chapter

1 Moving Averages 2 MACD (Moving Average Convergence Divergence) 3 RSI (Relative Strength Index) 4 Bollinger Bands 5 Stochastic Oscillator 6 ATR (Average True Range)

1. Moving Averages

Moving averages (MAs) smooth price data and help identify the trend. They are lagging indicators — they confirm trends, they do not anticipate them.

Price candles SMA 20 EMA 20

Type	Formula	Property
SMA (Simple)	Arithmetic average of the last N prices	Simple, reacts slower
EMA (Exponential)	Weights recent prices more heavily	More responsive, less lag
WMA (Weighted)	Linearly weighted, newest = highest weight	Between SMA and EMA

Golden Cross & Death Cross

Golden Cross: Short-term MA (e.g. SMA 50) crosses long-term MA (SMA 200) from below → long-term bullish signal.
Death Cross: SMA 50 crosses SMA 200 from above → bearish signal.
Note: MA crossovers are lagging and can generate many false signals in sideways markets.

💡 Popular MA combinations: 9/21 EMA (short-term) · 20/50 SMA (medium-term) · 50/200 SMA (long-term/Golden Death Cross)

2. MACD (Moving Average Convergence Divergence)

MACD is one of the most popular momentum indicators. It shows the relationship between two EMAs and helps identify trend direction, momentum and potential reversals.

Price candles MACD line (EMA12−EMA26) Signal line (EMA9 of MACD)

Signal	Meaning
MACD crosses signal from below	📈 Bullish buy signal
MACD crosses signal from above	📉 Bearish sell signal
MACD above zero line	Bullish momentum dominates
MACD below zero line	Bearish momentum dominates
Bullish divergence	Price makes lower lows, MACD makes higher lows → possible upward reversal
Bearish divergence	Price makes higher highs, MACD makes lower highs → possible downward reversal

Default settings: 12-26-9 (EMA 12, EMA 26, Signal EMA 9)

3. RSI (Relative Strength Index)

RSI measures the strength and speed of price movements on a scale from 0–100. It indicates overbought and oversold market conditions.

RSI (14 periods)

RSI level	Interpretation	Caution
> 70	Overbought — potential reversal	In strong trends RSI can stay at 70+ for a long time
50	Neutral line — trend direction	RSI above 50 = bullish trend, below 50 = bearish
< 30	Oversold — potential reversal	In downtrends RSI can stay at 30− for a long time

RSI divergence (like MACD): price and RSI move in opposite directions → strong reversal signal.
Default setting: 14 periods.

💡 RSI alone is not enough — always combine with trend analysis and other indicators. Overbought in an uptrend is not an automatic sell signal.

4. Bollinger Bands

Bollinger Bands consist of a middle band (SMA 20) and two outer bands at a distance of 2 standard deviations. The bands widen during high volatility and contract during low volatility.

Price candles Bollinger Bands (SMA20 ± 2σ)

Signal	Meaning
Bollinger Squeeze	Bands very tight → low volatility → large breakout imminent
Price touches upper band	Strong, but not necessarily a sell signal in an uptrend
Price touches lower band	Weak, but not necessarily a buy signal in a downtrend
Price outside band + candle returns	Strong reversal signal (band "touch-and-return")

%B Indicator: Shows where the price stands relative to the bands. %B > 1 = above upper band, %B < 0 = below lower band.

5. Stochastic Oscillator

The Stochastic Oscillator compares the closing price with the trading range of the last N periods (default: 14). It shows overbought/oversold conditions similar to RSI but reacts faster.

%K (Fast) %D (Signal, SMA3 of %K)

Range	Meaning
> 80	Overbought
< 20	Oversold
%K crosses %D from below (in oversold area)	📈 Buy signal
%K crosses %D from above (in overbought area)	📉 Sell signal

Slow Stochastic: %K of Slow Stochastic = %D of Fast Stochastic — reduces false signals in volatile markets.

6. ATR (Average True Range)

ATR measures the average trading range of the last N periods and is a pure volatility indicator — no directional statement. High ATR = volatile markets, low ATR = calm markets.

ATR (14 periods)

ATR for Stop-Loss Sizing

ATR is ideal for setting volatility-based stop losses rather than arbitrary percentage values:

Stop loss = Entry − (ATR × multiplier)

Example: Stock at $100, ATR = $2.50, multiplier 2×
→ Stop loss at $100 − $5 = $95
→ Stop is wide enough to absorb normal "noise"

Typical multipliers: 1.5× (tight), 2× (standard), 3× (wide/for swings).