Indicators Explained — RSI, Stochastics, MACD & Bollinger Bands

Overview: Turning Price Into Signals

Indicators process price and volume into formulas that quantify states hard to see by eye — overheating, neglect, momentum. They split into trend-following (MACD) and counter-trend (RSI, Stochastics); use them knowing their character.

---

1. RSI — Relative Strength Index (overbought/oversold)

RSI expresses whether price is overheated or neglected, from 0 to 100, based on the ratio of gains to losses over a period (default 14).

RSI	State	Typical reading
70+	Overbought	Watch for a pullback
30−	Oversold	Expect a bounce
50	Neutral	Trend-direction line

RSI Divergence

• Bearish divergence: price makes a new high, RSI makes a lower high → weakening momentum
• Bullish divergence: price makes a new low, RSI makes a higher low → weakening downside

---

2. Stochastics — A More Sensitive Oscillator

Shows where the current close sits within the recent high-low range. Made of %K (fast) and %D (slow) lines.

• Above 80 overbought / below 20 oversold
• In the oversold zone, %K crossing above %D → buy signal
• More sensitive than RSI, so more frequent signals → good for short-term, but more false signals

---

3. MACD — Trend and Momentum at Once

MACD reads trend direction and strength from the difference of a short and long EMA.

$$\begin{aligned} \text{MACD line} &= 12-\text{day EMA} − 26-\text{day EMA} \\ \text{Signal line} &= 9-\text{day EMA of the MACD line} \\ \text{Histogram} &= \text{MACD line} − \text{Signal line} \end{aligned}$$

Signal	Meaning
MACD crosses above signal	Buy signal
MACD crosses below signal	Sell signal
MACD above/below zero line	Uptrend/downtrend zone
Histogram growing/shrinking	Momentum accelerating/fading

---

4. Bollinger Bands — Price Position via Volatility

Bands set at 2 standard deviations above and below a center MA (usually 20-day) visualize volatility.

• Price stays within the bands ~95% of the time statistically
• Touching the upper band → short-term overheating / lower band → short-term weakness
• Squeeze (bands contracting): volatility shrinking → a big move (breakout) is near
• Expansion: a strong trend is underway

---

5. Combining Indicators

Combo	Synergy
RSI + MACD	Oversold (RSI) + golden cross (MACD) overlapping raises buy confidence
Bollinger + RSI	Lower-band touch + RSI below 30 → bounce zone
MACD + volume	Cross with volume behind it → higher confidence

---

Key Takeaways

1. Indicators split into trend-following (MACD) and counter-trend (RSI, Stochastics).
2. RSI 70/30 and Stochastics 80/20 mark overbought/oversold but give false signals in strong trends.
3. MACD reads trend and momentum via the cross, histogram, and zero line.
4. A Bollinger squeeze foreshadows a big move; divergence is a powerful reversal clue across indicators.
5. Combine 2–3 indicators of different character — avoid overuse.

Next lesson: At last, the Ichimoku Cloud. We dissect each component — how its five lines and cloud add the dimension of “time and balance” to trend.