On the one hand, modern trading software allows traders to use various technical indicators. In fact, when you just start your acquaintance with financial markets, you may be confused by this abundance. On the other hand, there are many traders who argue that technical indicators can mislead you and provide false signals. Let’s find out where the truth lies: should you use technical indicators or analyze only price action? Is it necessary to make a choice here at all?
Technical indicators are basically formulas that help to analyze historical chart data. They are precise, they save your time and provide substantial visual guidance to price charts. On the other hand, you shouldn’t think that any indicator will give you an opportunity to make 100% profitable trades.
Drawbacks of technical indicators
Technical indicators have their weaknesses. As they make calculations on the basis of the past prices, they don’t offer any external insights. So, if you trade stocks, technical indicators don’t give you any info about a company’s fundamentals. If you trade currencies, technical indicators don’t take into account the economic data.
In addition, indicators often lag behind the price chart. When the current price changes the most recent levels of an indicator will be redrawn, so if you entered a trade on the basis of these levels, you may get burned. Finally, different indicators may contradict each other, and the same indicator may show different things on different timeframes. All of the mentioned above discredits technical indicators in the eyes of many traders.
However, we advise you not to rush into disappointment with technical indicators. Bear in mind that the early versions of them existed even before the age of computers. Back then, those who bought and sold financial assets saw the merits in indicators. During the last century or so, specialists developed hundreds of various indicators. The software of today allows traders to develop their own indicators. All in all, such popularity proves that technical indicators are indeed quite useful. The trick is in using them correctly.
The right approach to technical indicators
The first rule you need to remember is that you shouldn’t expect too much from any indicator. In other words, feel free to expect that your market analysis will become more efficient. However, don’t count on switching off your mind and transferring the decision making to one single indicator.
We recommend you to spend some time getting to know the indicators, especially the classic ones. You will soon discover that each indicator has its own logic and purpose. For example, the Stochastic Oscillator evaluates the market’s momentum. To do that it compares the closing price to a price over a certain period of time. Then the oscillator represents the results in the form of the lines that fluctuate between 0 and 100. This allows traders to read its signals with a single glance.
In addition, there are various types of indicators, such as trend indicators, oscillators, volatility indicators. Technical indicators will be of value to you only if you use them for their purpose and in line with their type. For instance, trend indicators are edged to help traders to identify and follow a trend. If you use a trend indicator when the price is in a range, it won’t live up to its full potential. The indicator may even give you wrong information, whereas in a trend the quality of its performance will substantially increase. Oscillators show when the asset gets overbought or oversold. They can signal the start of countertrend moves and be very helpful in ranges.
The right number of indicators
Another important rule of indicator trading is to use several indicators to determine when and how to enter the market. A single indicator will likely produce many false signals. You can easily check that yourself.
For example, it’s recommended to sell when the MACD histogram goes below the signal line. However, if you sell every time that happens, you will have a lot of bad trades. A way out here is to add another indicator of a different type to act as a filter. For example, use a Moving Average to determine the trend.
This way you will be able to follow sell signals from the MACD only when the price is below the MA and the line has a bearish bias. Do that and you will see that the percentage of good signals will significantly increase only with this simple step.
Remember though, that too many indicators will also be bad for your chart. This is called ‘overanalysis’. After all, you will need to see the price itself behind the various indicator lines. The recommendation is not to use more than 5 indicators at ones. In most cases, 3 indicators should be more than enough for a strong trading strategy.
All in all, technical indicators represent a key part of technical analysis. Do you absolutely need technical indicators for profitable trading? No. At the same time, they can provide you with strong analytical support and enhance the results of your performance. This makes technical indicators worth studying and using.