In this post I cover the pros and cons of trading indicators, then offer some tips on how to use them. Sounds good? Please read on.
Trading Indicators?
Trading indicators (also called technical indicators) are mathematical derivatives of market data, primarily price and volume. They form a vital part of many traders’ technical toolkit. Indicators can be overlaid on a price chart (think Bollinger Bands) or appear in a separate panel below a price chart (think RSI).
Since indicators present price in a different way, it helps traders view price charts from a different perspective. Discretionary traders often use them as guide to make trading decisions, while mechanical traders use them to remove the need to make trading decisions by automating their rules / strategies.
While their are other types of indicators, such as those that measure sentiment and breadth, the main focus here will be on the more traditional indicators that’s based on price and volume.
Pros of Trading Indicators:
- Sometimes price can be noisy, which can make decision-making difficult. This is where indicators come in, they can act as a “filter”, helping you remove the noise.
- They can show you when price is trending or ranging.
- They can alert you when it is time to start paying attention to your charts – that a trade might be setting up.
- You can use indicators to confirm your analysis.
- They are a big help when it comes to scanning (especially in the world of stock trading).
- They can be used to add confluence to your setups, i.e. price is at support / resistance + a moving average (dynamic support / resistance).
- They make back testing a lot easier.
Cons of Trading Indicators:
- Many traders argue that because indicators are derived from price / volume, they are lagging and that using pure price / volume to trade is best.
- Beginner traders often fall into the trap of putting too many indicators on their charts in the hopes of finding the holy grail trading strategy. Off course, this is not the fault of any particular indicator, but more so of the individual.
- Indicators often give false signals. Think of a moving average crossover system crossing back and forth, i.e. whipsawing.
- Indicators can be manipulated. Think of a trader making the period of the RSI shorter in order to get more overbought / oversold signals.
- Indicators ignore external market events. Think of a stock going oversold (based on some oscillator) because of a very bad news event (bad earnings, fraud, etc.).
Tips on Using Trading Indicators:
- Accept that there is no such thing as a perfect indicator.
- Study your indicators, get to know all their nuances. Back test them.
- There’re times when markets are trending and ranging. Know which type of indicator best fits the market condition you’re trading.
- Use indicators in conjunction with price. An example would waiting for price to confirm your indicator, like: your oscillator is not just oversold, but also on support, and you are seeing signs of price reversing (maybe a hammer).
- Try to limit the amount of indicators you have on your chart. Don’t fall into the trap where you think 3 different oscillators being overbought / oversold at the same time will improve a trade’s outcome.
Note: While some say indicators are lagging, others see indicators like the RSI giving early warning signs that price might revers at overbought / oversold levels. Hence, they see the indicator as leading.
Finally:
Positive or negative, in the end it doesn’t matter what people say about indicators. Find and trade what what works for you.
Thanks so much for taking the time to read this post, I hope you’ve found it useful. All the best with your trading.
Thanks and Regards,
Trading SOS SOS
