7 best indicators for day trading

Day trading can be a fast-paced and thrilling environment with lots of potential opportunities. But it can also be a risky activity – it requires knowledge, patience and time. Nonetheless, there are a few technical tools that can help you manage your risk and optimise your strategy. Let’s take a look at what are the best indicators for day traders.

• What is day trading?

• Why use trading indicators for day trading?

• 7 best indicators for day trading
• MACD
• Relative Strength Index
• Stochastic Oscillator
• Bollinger Bands
• On Balance Volume
• Average Directional Index
• PSAR

What is day trading? 

Day trading is the act of buying and selling one or more financial instruments within the same day or even multiple times over the course of a day. Day traders often trade on margin to increase their exposure to the market, and they never hold onto a position overnight.

They can trade many markets and asset classes from foreign exchange to indices and more. If you are a beginner, day trading stocks can be a way to familiarise yourself with the markets and learn about strategy and analysis.

However, it is a risky practice that requires a lot of research and experience. Trading on margin means that losses are magnified, so if prices go in the opposite direction of what you were expecting, you could experience a quick and potentially significant loss. You should always take measures to manage your risks such as attaching limits and stop losses, which you can learn how to do in a risk-free environment by signing up to a City Index demo account.

Why use trading indicators for day trading?

Most day traders use technical analysis to make entry and exit decisions. Trading indicators are appropriate for day trading because they can help you quickly identify the short-term trading patterns and trends that are essential for this type of strategy.

More specifically, technical trading indicators can help you make sense of complex price information to know when to buy and when to sell. It is very difficult to make successful decisions if your strategy is only based on fundamental analysis, or no analysis at all.

There are a variety of technical indicators, some predict market movements, while others measure volume and volatility.

7 best indicators for day trading

There are hundreds of indicators you could choose from depending on your strategy and trading preferences. Here are 7 popular indicators:

1. MACD
2. Relative Strength Index
3. Stochastic Oscillator
4. Bollinger Bands
5. On Balance Volume
6. Average Directional Index
7. PSAR

1. Moving average convergence divergence (MACD) 

Moving average convergence divergence (MACD) can reveal changes in an instrument’s overall price movement depending on a plot of two moving averages: the MACD line and the signal line. Most traders use this technical indicator to confirm current market conditions, based on whether the two lines converge or diverge.

• The MACD line is calculated by subtracting a longer-term EMA (typically 26 periods) from a shorter-term SMA (typically 12 periods)
• The signal line is a moving average of the MACD line (usually nine periods)

When the two lines converge, the MACD line stays near the signal line. This indicates a slowdown of the ongoing trend and a possible reversal. On the other hand, when the two lines diverge, it means that the MACD line is changing faster than the signal line, and this suggests increasing momentum in the current trend.

MACD can be easily adapted for day traders and is very useful for confirming conditions that can be used to your advantage when quickly entering and exiting trades multiple times a day.

For example, you could use it to generate short-term signals with approaches such as the MACD crossover strategy. It focuses on when the MACD line and signal line cross one another. When the MACD line crosses above the signal line, a bullish signal is generated and when the MACD line crosses below the signal line, it’s considered a bearish signal.

2. Relative strength index (RSI)

The relative strength index (RSI) is a momentum indicator that measures the speed and change of price movements. Like other momentum indicators, you can use it to find overbought or oversold situations, find divergences, validate trends and trend reversals or predict the price behaviour of a given instrument.

The RSI has a range value between 0-100. Generally, when the RSI value falls below 30, the market is considered to be oversold. When it rises above 70, the market is generally considered to be overbought. Similarly, bullish and bearish divergences can be spotted by comparing the highs and lows of price movements and the RSI, so it is a good indicator to analyse and follow trends.

The RSI is useful for day trading because it identifies possible entry and exit points and is helpful when following trends. Day traders often choose to lower the RSI period setting to increase the sensitivity of the indicator. An example of this could be a range of 9-11.

3. Stochastic oscillator

The stochastic oscillator is a momentum indicator which compares the closing price of an instrument to the range of its price over a certain period of time. It is used to generate trading signals, determine possible trading opportunities such as overbought and oversold conditions, or forecast entry and exit points.

Readings above 80 are regarded as a sign of the market being overbought, while a reading of 20 or below is considered oversold.

The stochastic oscillator is calculated by using two lines, the %K and %D, which usually appear on a sub-chart below the price chart. The %K line compares the market’s close for the day to its trading range over a certain period) and the %D line represents the 3-period average of %K.

If you want to use this indicator for day trading, it is important to tweak the settings to meet your strategy. An example of settings that could be helpful when day trading, would be using the %K length at 14 and %K smoothing at 1. This will generate more frequent signals for faster decision-making.

4. Bollinger Bands

Bollinger Bands are another momentum indicator. The tool is made up of a simple moving average sandwiched between two lines – which plot a positive and a negative deviation. It measures the volatility of a given market - the upper and lower bands show how much the price is deviating from its average.

While the middle band is the average price of an instrument over a specific period of time, the upper band is the middle band plus two standard deviations and the lower band is the middle band minus two standard deviations. The bands widen during volatile periods and contract when volatility is low. If the latter is the case, they usually appear to move together.

Bollinger bands are commonly used by day traders because it generates a lot of signals and helps with the clarification of price patterns.

The best strategy for day trading is to adapt the settings of the indicator to shorter periods, ensuring that the timeframe includes enough data to give a clear overview of the market price. It is best used in combination with other indicators to make informed decisions about price volatility.

5. On-balance volume (OBV)

On-balance volume (OBV) measures buying and selling pressure. It is a trading momentum indicator that uses volume flow to predict changes in price.

OBV presents a cumulative total of volume, and traders look at the nature of its moments over time rather than at the actual quantitative value. When price and OBV are hitting higher highs and higher lows, the trend is likely to continue moving upward and vice versa.

When day trading, it is important to adjust the settings for very short periods of time to follow the volume or a given instrument. For example, if during a trading range of an hour the OBV is falling, this can be interpreted as a warning of a downward breakout.

6. Average directional index (ADX) 

The ADX indicator is another tool that helps traders measure the strength of trends, and appears as an oscillator underneath trading charts. It is plotted from 0-100 – a reading above 25 indicates a strong trend while 25 or below will suggest a weak trend or no trend at all.

The most common use is to measure the momentum behind a trade to make an informed decision on whether to enter or exit a trade. You can use the ADX indicator to help confirm that a new trend is underway when it has been detected by another indicator.

In day trading, the ADX indicator can provide some extra confidence when spotting short-term trades with the help of other indicators. The indicator can be added to short-term charts to make it more sensitive towards short-term price fluctuations.

7. PSAR

The parabolic stop and reverse (parabolic SAR or PSAR) is a technical indicator that generates dots on a chart. To read it, you simply look at the dots. If they are above the current price, this means that the price is falling. If the dots appear below the price bar, it means that it is rising.

If the dots cross over the price, there is a potential reversal. If the dots go from above the price to below, you might think of buying – whereas if they move from below to above, you might think of selling. This is the most popular way to trade using the parabolic SAR, but it can also be used in other strategies like exiting trades or setting stop losses.

For a short-term trading strategy such as day trading, you would use a shorter time period for the chart – setting it to look at movements hourly, in minute intervals, or even seconds. It is popularly used for setting trailing stop losses because it is one of the easiest indicators to understand on a trading chart.

A note on day trading with indicators

It is recommended to use a few of these indicators in combination with each other. If looked at in isolation, they can generate false signals, especially in markets that are not strongly trending or when dealing with unforeseen circumstances.

A good strategy is to combine different types of indicators such as a momentum indicator, a trend-following indicator and a volatility indicator, for example.

Start day trading with indicators today

Follow these steps to start using the indicators covered below with City Index today:

1. Open your City Index account, or log in if you already have one
2. Add some funds
3. Find the indicators list on the chart of your chosen market, and choose your tools
4. Open your buy or sell position

Alternatively, you can practise trading with a cost-free City Index demo account. You’ll get full access to our platform, preloaded with virtual funds. So, you can test out your trading strategy with zero risk.