You’ve probably heard this before:

“Indicators are useless.”

Well, that’s not entirely true.

Saying "indicators are useless" is like saying "hammers are useless" because you tried to use one as a screwdriver.

Indicators are only useless if you don’t know what problem they’re solving.

When used correctly, indicators can help you:

  • Identify strong stocks
  • Define the trend
  • Spot stocks that are oversold and about to make a bounce higher

Let me share a few indicators that help you do just that…

Rate of change (to identify strength)

The rate of change (ROC) indicator measures the % change in price.

For example, if Tesla went from $100 to $200, then the ROC value is 100 because it went up 100% during the period.

So, how do you use the ROC indicator?

This is useful when you have many trading opportunities and don’t know which to trade.

For me, I’d pick the stock with the highest ROC value (over the last 100 days). The higher the better because it tells me the stock has a strong momentum and is likely to continue higher. Kind of like how one kid crying in a daycare causes all the kids to cry.

Moving average (to identify trend)

The moving average indicator calculates the average price over a given period.

For example, the 50-day moving average calculates the average price over the last 50 days.

So, what can you use the moving average indicator for?

One way is to define the trend.

Yes, I know a trend is a series of higher highs and higher lows.

But what if you get a lower high and a higher low? Now, is the trend still intact or invalidated?

Your brain starts hurting more than mine does when my kids ask me to help with their math homework.

That’s where a moving average can help you to define the trend without subjectivity.

For example:

  • If the stock price is above the 200-day moving average, then it’s in a long-term uptrend.
  • If the stock price is above the 50-day moving average, then it’s in a medium-term uptrend.

And finally…

Relative strength index (to identify “over-stretched” levels)

The relative strength index (RSI) measures the momentum of a price movement.

It’s calculated by comparing the average gains to the average losses (over a fixed period).

For example:

  • If the 10-day RSI is below 30, it means the average losses are much larger than the average gains over the last 10 days.
  • If the 5-day RSI is above 70, it means the average gains are much larger than the average losses over the last 5 days.

If you think about it…

The RSI indicator tells you how “stretched” the price is relative to recent history. The wider the “stretch”, the more extreme the RSI values will be (below 30 or above 70).

This is useful for a mean reversion trading system because it tells you when a stock is “over-stretched” and could make a bounce higher.

Now, you don’t just blindly buy when a stock is oversold because what’s cheap can become cheaper.

So a few things I look for are…

  • The stock is in a long-term uptrend (above 200-day moving average).
  • The rate of change is positive over the last 100 days (the higher the better).
  • The 10-day RSI is below 25 (signalling the stock is about to snap back higher).

If you want to learn more, I go into more details in my book, Trading Systems That Work.

Cheers,

Rayner “indicators-are-not-useless” Teo