Moving averages, RSI, MACD, Bollinger Bands

Indicators don't know anything the chart doesn't. Every one of them is a calculation based on past prices — mostly the close. That doesn't make them useless. It makes them summaries: tools that turn a messy chart into a clear answer to one specific question. The skill is knowing which question each indicator answers, and never asking it to answer a different one.

What you'll learn

• How moving averages work, and how to use them for trend and dynamic support/resistance
• What RSI measures, why "overbought" doesn't mean "sell", and how to use divergence
• How MACD is built from moving averages, and what its lines and histogram show
• How Bollinger Bands measure volatility, and what a squeeze means
• The trap each indicator sets for beginners

1. Moving averages — trend

A moving average (MA) is the average closing price over the last N candles, recalculated each candle.

Common settings: 20 (short-term), 50 (medium-term), 200 (long-term).

How traders use them

• Trend filter: price above a rising 200 MA → only look for buys; below a falling 200 MA → only sells.
• Dynamic support/resistance: in strong trends, pullbacks often stall near the 20 or 50 EMA.
• Crossovers: the 50 crossing above the 200 (often called a "golden cross") or below it (a "death cross") mark longer-term trend shifts.

2. RSI — momentum

The Relative Strength Index, developed by J. Welles Wilder, compares the size of recent up-closes with recent down-closes, on a scale of 0 to 100. The standard setting is 14 periods.

• Above 70 is traditionally labelled overbought; below 30, oversold.

The big trap

"Overbought" does not mean "about to fall". In a strong uptrend, RSI can stay above 70 for a long time while price keeps rising. Selling every RSI reading above 70 in a trend is one of the most expensive beginner habits.

Better uses

• Trend character: in many uptrends, RSI tends to hold above roughly 40–50 on pullbacks; in downtrends, it tends to stay below roughly 50–60 on rallies. A change in that behaviour can hint at a changing trend.
• Divergence: price makes a higher high while RSI makes a lower high (bearish divergence), or price makes a lower low while RSI makes a higher low (bullish divergence). This shows momentum fading. It's a warning, not an entry signal — divergences can persist through several swings.
• Ranges: in a clear range, oversold readings near support and overbought readings near resistance can add confluence.

3. MACD — momentum and trend

MACD (Moving Average Convergence Divergence) is built from moving averages:

What it shows

• Above zero: the short-term average is above the long-term one — bullish momentum.
• MACD crossing its signal line: momentum shifting.
• Histogram shrinking: momentum fading, even if price is still rising.
• Divergence with price — as with RSI.

4. Bollinger Bands — volatility

Created by John Bollinger, the standard setting is:

• Middle band: 20-period SMA
• Upper and lower bands: 2 standard deviations above and below it

The bands widen when volatility rises and narrow when it falls.

How traders use them

• Squeeze: unusually narrow bands signal low volatility, which often precedes expansion — a potential breakout setup (direction still needs to come from structure).
• Ranges: touches of the outer bands near support and resistance can mark stretched prices.
• Trends: in strong trends, price can "walk the band" — repeatedly closing near the upper (or lower) band.

5. Choosing and setting indicators

Default settings are fine. Tweaking settings until an indicator fits past charts perfectly is a form of overfitting (Module 3.4). Choose sensible defaults, then test.

Worked example: indicators as supporting evidence

(Illustrative EUR/USD, H4.)

1. Trend: price above a rising 200 SMA → buys only.
2. Pullback: price retraces to the rising 50 EMA, which lines up with a prior resistance-turned-support zone.
3. Momentum: RSI dips to 44 and turns up — consistent with an uptrend pullback, not a trend change.
4. Trigger: a bullish engulfing candle at the zone.

The indicators didn't create the trade. They confirmed what structure and location already suggested — and one of them (RSI holding above 40) helped distinguish a pullback from a reversal.

Common beginner mistakes

• Selling "overbought" and buying "oversold" in trending markets.
• Trading MA crossovers in ranges.
• Treating related indicators as independent confirmation (MACD + MA crossovers).
• Endlessly adjusting settings to fit past price action.
• Using indicators instead of structure, rather than alongside it.

Key terms

Practice

1. Add a 200 SMA and 50 EMA to a D1 chart of your market. Over the last year, how often did pullbacks stall near the 50 EMA while price was above the 200?
2. Add RSI(14). Find three times RSI went above 70 during an uptrend. What happened next?
3. Find one bearish or bullish divergence. How many candles passed before price actually turned?
4. Add Bollinger Bands (20, 2) and find the last three squeezes. Which way did they break, and did structure hint at the direction beforehand?

Quick recap

• Moving averages show trend and dynamic support — but lag and whipsaw in ranges.
• RSI measures momentum; "overbought" isn't "sell". Use trend character and divergence.
• MACD is built from EMAs — don't double-count it with MA crossovers.
• Bollinger Bands measure volatility; squeezes often precede expansion.
• Indicators confirm structure and location — they don't replace them.