Using Trading Indicators Effectively

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Using Trading Indicators Effectively

Many active traders and investors utilize technical trading indicators to assist them discover high-probability trade entry and exit locations. Hundreds of indicators are accessible on most trading platforms; as a result, it is possible to utilize too many or inefficiently. This post will teach how to choose several indications, minimize information overload, and optimize indicators to get the most out of these technical analysis tools.

Using Multiple Indicators

  • Technical indicators are mathematical computations based on the history and present price or volume activity of a trading instrument. Technical analysts utilize this data to assess past performance and forecast future pricing. Indicators do not give explicit buy and sell signals; instead, a trader must interpret the signals to find trade entry and exit positions that are consistent with his or her own distinctive trading style. There are several sorts of indicators, such as those that interpret trend, momentum, volatility, and volume.
  • Avoiding Redundancy: The word “multicollinearity” refers to the repeated counting of the same information in statistics. This is a prevalent issue in technical analysis when the same sorts of indicators are used on the same chart. The findings provide duplicate signals that might be deceptive. Some traders use many indicators of the same kind on purpose, hoping to obtain confirmation for a predicted price move. In practice, though, multicollinearity may make other variables look less relevant and make correct market evaluation harder.

Figure 1.

Image by Sabrina Jiang © Investopedia2021

  • Using Complementary Indicators: To avoid the issues associated with multicollinearity, traders should use indicators that complement, rather than duplicate, each other’s findings. This may be accomplished by using many sorts of indicators on a chart. A trader might use one momentum indicator and one trend indicator, such as a stochastic oscillator (a momentum indicator) and an Average Directional Index, or ADX (a trend indicator).Figure 1 depicts a chart using both of these markers. Take note of how the indicators convey various types of information. Because each offers a unique assessment of market circumstances, one may be used to validate the other.
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Keep Trading Charts Clean

  • Keeping Charts Clean: Because a trader’s charting platform serves as his or her doorway to the markets, it is critical that the charts aid, rather than impede, the trader’s market research. Charts and workspaces that are easy to read (the full screen, including charts, news feeds, order entry windows, and so on) may increase a trader’s situational awareness, enabling the trader to quickly comprehend and react to market events. Most trading systems allow for extensive customization of chart color and design, including everything from the background color to the style and color of a moving average to the size, color, and font of the words that show on the chart. Setting up clean, aesthetically attractive charts and workspaces aids traders in making efficient use of indicators.
  • Information Overload: Many traders now utilize numerous monitors to show various charts and order entry windows. Even if six monitors are employed, it is not a good idea to dedicate every square inch of screen area to technical indications. Information overload happens when a trader seeks to comprehend so much info that it is effectively lost. Some call this analysis paralysis; if a trader is confronted with too much information, he or she will most likely be unable to reply. One way to minimize information overload is to remove any superfluous signs from a workstation; if you’re not using it, get rid of it—this will assist reduce clutter. Traders may also examine charts to ensure that they are free of multicollinearity; if numerous indicators of the same kind are present on the same chart, one or more indications can be deleted.
  • Organizing Tips: Creating a well-organized workplace that only employs relevant analytical tools is a process. A trader’s quiver of technical indicators may alter over time, based on market circumstances, techniques adopted, and trading style.

Figure 2.

Image by Sabrina Jiang © Investopedia2021

How to Use Trading Indicators Effectively

Charts, on the other hand, may be saved after they have been properly configured. It is not essential to reformat the charts each time the trading platform is closed and reopened (for instructions, see the trading platform’s Help section). Trading symbols and technical indicators may be modified without affecting the workspace’s color scheme or layout. Figure 2 depicts a well ordered desk. Consider the following when designing easy-to-read charts and workspaces:

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  • Colors: Colors should be simple to see and have lots of contrast so that all data is visible. Furthermore, one background color may be selected for order entry charts (the chart used for trade entrance and exits), while another background color can be used for all other charts of the same symbol. When trading many symbols, a separate backdrop color for each symbol might be utilized to help isolate data.
  • Layout: Having more than one monitor helps to create a user-friendly workstation. One display may be utilized for order input and the other for pricing charts. If the same indication is used on many charts, it is best to set similar indicators in the same spot on each chart and use the same colors. This makes finding and interpreting market activity on distinct charts simpler.
  • Sizing and Fonts: Bold and crisp fonts make it easier for traders to understand figures and text. Font style, like colors and layout, is a personal choice, and traders may experiment with various styles and sizes to discover the combination that produces the most aesthetically appealing result. Once comfortable writing has been established, the same font type and size fonts may be used on all charts to provide consistency.

Optimizing Indicators

  • User-Defined Input Variables: It is up to each trader to pick which technical indicators to use and how to utilize them most effectively. Most widely used indicators, like as moving averages and oscillators, allow for some customization by simply adjusting the input values, which are user-defined variables that change the indicator’s behavior. Variables such as the look-back time and the kind of price data utilized in a computation may be changed to give an indicator drastically different results and highlight distinct market circumstances. Figure 3 is an example of the kinds of input variables that may be changed to vary the behavior of an indicator.
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Figure 3.
  • Many of today’s modern trading systems enable traders to conduct optimization studies to find the input that results in best performance. Traders may specify a range for a certain input, such as a moving average length, and the platform will run the math to determine which input produces the best results. Multivariable optimizations examine two or more inputs at the same time to determine which combination of variables produces the best results. Optimization is a critical stage in building a goal-oriented strategy that determines trade entry, exit, and money management criteria.
  • Overoptimization:While optimization studies can assist traders in identifying the most profitable inputs, over-optimization can result in a situation in which theoretical results appear fantastic, but live trading results suffer because the system has been tweaked to perform well only on a specific, historical data set. While it is outside the focus of this article, traders who do optimization studies should be cautious not to over-optimize by knowing and using correct backtesting and forward testing procedures as part of the entire strategy creation process.

The Bottom Line

It is vital to remember that technical analysis is concerned with probability rather than certainties. There is no combination of indicators that can anticipate market movements 100% of the time. While having too many indicators or using them incorrectly might distort a trader’s perception of the markets, traders who employ technical indicators carefully and efficiently can more precisely locate high-probability trading setups, enhancing their chances of success in the markets.

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