Trading with indicators
What are indicators?
Indicators take the raw data from a chart and present it in a different format to assist in making trading decisions. There are different types of indicators ranging from trend indicators, and momentum to oscillators, all of which help to visualise the condition of a market.
Essentially some technical indicators can be used for trending markets whilst others can be used for non-trending markets.
Why use technical indicators?
The main focus for a trader when using technical indicators is to help time trades for entries and exits. And although the calculations and formulas of some of the technical indicators may appear to be complex or scientific, the art is learning how to read the signals.
Indicators for trending markets
When markets enjoy a sustained trend moving in one direction with minor corrections, indicators such as the Moving Average, MACD and Parabolic SAR can be useful. These indicators can help a trader by staying on the right side of the market as long as there are no major corrections.
Indicators for non-trending markets
At times when the markets are not in a trend mode but instead moving between a range a trader can apply a Stochastic Oscillator or RSI to assess when the market becomes short term overbought or oversold.
Advantages of technical indicators
Analysing a chart without indicators is a skill that comes with experience. Some traders feel that trading without indicators is the antithesis of technical analysis. In other words, a chart without lines and squiggles is not a technical chart.
This is not necessarily true. There are many professional traders who can read charts without any indicators at all and this is referred to as reading Price Action. These traders feel that having too much information can be a distraction as to what the price is already showing us.
Disadvantages of technical indicators
Remember, technical indicators derive their signals from price this means that the indicator can be "lagging" or delayed. It is not uncommon for technical indicators to provide a false signal in some cases, and traders should always be aware of this.
A popular indicator that helps to filter out the noise of the market. It is a lagging indicator, as it is based on past prices. It is literally the simple average of a market over a defined period – e.g. 30 days.
Moving Average Convergence Divergence, a momentum indicator that shows the relationship between two moving averages. It is calculated by subtracting the 26 day exponential moving average from the 12 day.
This indicator keeps track of momentum, and is used by traders to try to anticipate when a market is going to lose momentum and change direction. It is usually shown as a series of dots above or below the market on your chart.
No technical indicator can provide a 100% accurate signal and no trading strategy should be based purely on the signal of a technical indicator. It is important to use trade, risk management and money management in conjunction with all other aspects of trading. The use of technical indicators is subjective and results can vary from trader to trader.