Module 4 · Lesson 3 of 12 · Volume and indicators · About 6 minutes
Technical Indicators Explained: MA, RSI, MACD, Bollinger, ATR
On this page
Before you read: Candlestick Anatomy: Open, High, Low, Close and Wicks
What you will learn
- What five widely used indicators measure: moving averages, RSI, MACD, Bollinger Bands and ATR.
- How each is calculated, in plain words.
- How historical-input formulas and smoothing differ, why they do not know future prices, and why there is no universal ordering of every indicator turn. What each one cannot tell you.
What is an indicator?
If an indicator is calculated from past prices, can it know anything the prices do not?
A technical indicator is a formula applied to past prices, and sometimes volume, that produces a new line or number. It is a way of summarizing data you already have. It cannot contain information that was not in the inputs, but it can make some features easier to see, such as the average level, the pace of change or the size of recent moves.
Every indicator has settings, usually a lookback length. The numbers quoted below are common defaults, which are conventions, not optimal values. Changing them changes the line. Indicators transform their stated inputs; they cannot know future prices from a formula alone. Smoothing usually gives a quieter line that responds more slowly, but there is no universal rule about which indicator turns or crosses first. When you compare indicators, write down the inputs, the smoothing, the starting value and whether the current bar has closed.
What is a moving average?
If you smooth out the wiggles, what are you left with, and what have you thrown away?
What it measures: the average price over a chosen number of recent bars.
How it is calculated:
- A simple moving average (SMA) adds up the last N closes and divides by N. With each new bar, the oldest close drops out and the newest is added.
- An exponential moving average (EMA) also averages recent closes but gives more weight to the newest ones. Older closes never fully drop out; their influence fades. An EMA usually responds sooner than an SMA of the same length, but not every EMA turn comes before every SMA turn. That depends on the length, the starting value and the price path.
Illustrative arithmetic only: closes of 10, 11, 12, 13 and 14 give a five-period SMA of 60 ÷ 5 = 12.
What it lags: a moving average summarizes its chosen observations/weights rather than forecasting turns. Greater smoothing can delay responsiveness in familiar examples, but the exact turning sequence is not a universal theorem. A crossing is a relationship between averages at that observation, not an instruction or guaranteed future move. See Moving Averages in Depth: SMA, EMA, Lag and Crossovers.
Indicators diagram
Illustrative diagram constructed for teaching. Not real market data.
The diagram shows a constructed price series with a short and a long moving average that turn after price turns, and an RSI panel beneath with conventional reference lines at 70 and 30. It is constructed for teaching and is not real market data.
What is RSI?
If a market rose a lot recently, is that the same as saying it rose too much?
What it measures: the relative strength index (RSI) compares the size of recent gains with the size of recent losses, scaled from 0 to 100.
How it is calculated: over a lookback (14 bars is a common default), take the average of the up-moves and the average of the down-moves. Divide the average gain by the average loss to get a ratio, then convert it to a 0–100 scale. When gains have dominated, RSI is high; when losses have dominated, it is low. The original method uses a particular smoothing for the averages, and platforms follow it with small variations.
Conventional reference lines: many charts draw lines at 70 and 30, and people often call readings above 70 “overbought” and below 30 “oversold”. Those words are labels for the arithmetic, not descriptions of value. In a strong, persistent move RSI can stay above 70 or below 30 for a long time.
Wilder-style RSI uses recursively smoothed average gains and losses. The length of 14 controls how much smoothing is applied. It is not a hard cutoff that ignores everything older than 14 bars. If G and L denote prior smoothed averages, the next values are Gnew=(13G+current gain)/14 and Lnew=(13L+current loss)/14. Then RSI=100−100/(1+Gnew/Lnew) when the denominator is defined. An older observation’s influence decays rather than disappearing at one boundary. Seed conventions and edge cases such as zero average loss require the platform definition.
Small completed illustration with explicitly stipulated seed G=1, L=1 price unit, not a claim to seed real charts this way: a new +2 price-unit change has gain 2/loss 0. Gnew=15/14, Lnew=13/14, RS=15/13 and RSI≈53.571429. The previous averages still contributed. A high RSI summarizes smoothed relative gains, not fair value or a required reversal. See RSI and Stochastic Oscillators: What Overbought Really Means.
What is MACD?
What does it tell you when a fast average pulls away from a slow one?
What it measures: MACD (moving average convergence divergence) tracks the gap between a shorter and a longer exponential moving average.
How it is calculated: with common defaults:
- The MACD line is the 12-period EMA minus the 26-period EMA.
- The signal line is a 9-period EMA of the MACD line. (“Signal line” is the technical name of this line; it is not a recommendation.)
- The histogram is the MACD line minus the signal line.
When the shorter average is above the longer one, the MACD line is positive. Its rise and fall describe whether that gap is widening or narrowing.
The MACD line is the difference between two moving averages; it is not an average of them. The signal line is a separate smoothing of that difference. So there is no universal rule that every MACD turn comes later than a turn in either input average. Because the histogram is MACD minus signal, the histogram crosses zero on the same bar that MACD crosses its signal line. That says nothing about when MACD crosses its own zero line. See MACD Explained: Lines, Histogram and What Crosses Mean.
What are Bollinger Bands?
How do you tell whether a price is far from its recent average, compared with how far it usually strays?
What it measures: a middle line plus two bands that widen when prices have been spread out and narrow when they have been compact.
How it is calculated: the middle band is a moving average (20 periods is a common default). The upper and lower bands are set a multiple of the standard deviation of those closes above and below it (2 is a common default).
What it lags: the bands describe recent dispersion. Price touching or crossing a band says the latest close is far from the recent average relative to recent variability; it says nothing about whether it will return. In steady trends, price can travel along one band for an extended period.
What is ATR?
How far does this market usually move in one bar, and how would you know?
What it measures: average true range (ATR) measures recent volatility as an average bar size, in price units.
How it is calculated: for each bar, the true range is the largest of three distances: high minus low; the high minus the previous close; and the previous close minus the low. The last two capture gaps. ATR is an average of the true ranges over a lookback, commonly 14 bars.
What it lags: ATR describes how much price has been moving, not in which direction, and not how much it will move next. It changes slowly, so a sudden shift in volatility shows up gradually.
What happens when indicators are combined?
If three indicators agree, are they three pieces of evidence or one piece seen three times?
Many indicators are built from the same closing prices, so they tend to agree with each other. Moving averages, MACD and RSI all respond to the same recent movement. Adding more of them can create a feeling of confirmation without adding new information. Indicators built on different inputs, such as volume (trading volume, VWAP), at least describe something different.
What this does not tell you about indicators
- What any reading means for the next bar.
- Which settings suit any market; defaults are conventions.
- Anything about who is trading or why.
Check yourself
Reflect on these; there is no score.
- Closes of 20, 22, 21, 23 and 24: what is the five-period simple moving average? Hint: add and divide by five.
- What does changing moving-average length change, and must every longer-average turn occur later?
- RSI has been above 70 for 20 bars. What does that describe without saying “overbought”?
- Which of the five indicators here measures size of movement but not direction? Hint: true range.
Trademark note. Bollinger Bands is a registered trademark of John A. Bollinger.
Reflect on your own process
- Which indicator settings in your written plan are platform defaults, and have you recorded why you kept or changed them?
- When several of your indicators agree, how does your checklist tell apart new evidence from the same closes counted again?
- How would you check, by hand, one indicator value your platform shows you?