Indicators have been around as technical analysis was invented. But with each passing year, the number of new indicators introduced hitting the market is astounding.
Not only that, the latest technology is able to calculate complex formulas that the even the most complex indicators serve well in real time. But what does one choose to test and use to create a successful robust strategy? A trader can spend the entire lifetime learning and combining all of them and still cannot come close to get a decent result. Understanding how each indicator is formulated and verifying how they work and display in REAL TIME is the key. Many indicators look very good in historical charts, but they show ambiguous numbers when they come down to calculating with the bouncing prices live.
There are two types of indicators: timing and trend. These should be view in this way to catch the basic essence of the market mechanics. If one looks at all the trading masters, they all follow the trend of the market. This is the only way to get the big wins with the high probability to turn the trade into a win. All the statistics have proven this. The second element and probably the most important, is the timing of the entry and exit. Combining this with the going in the right direction will complete the strategy.
Timing indicators are normally called oscillators where they have a maximum limit and a minimum limit such as Stochastics, RSI, among others where the minimum is 0 and the maximum is usually 100.
Figure 1 Example of an oscillator.
The trend indicators have no upper or lower limits, from high positive maximum to low negative minimum, all depending on the prices and how far they go. These trend indicators are DMI, MACD to name a few.
Figure 2 Example of a trending indicator.
Since trend indicators are vital, so the rule is: always trade on the side of the trend. So the first step is to check the trend, which way the money the pushing the prices. Once that is established, look at the oscillator to time the entry. It was mentioned earlier that the indicator readings are extremely different when it’s not in real time and when they are not. With historical charts, the readings seem to indicate a clear entry or exit signal, but in real time, it’s more ambiguous.
Combining then together the chart begin to give better gauge of what the market is likely to do next, at least a better probability of when to stay out of the market.
Figure 3 Stochastics and MACD working together.
In Figure 1, the chart shows the trend is rising (MACD moving upwards). If the trade was taken right now, would not be prudent since the market has already moved and the trade is taken too late. Adding the oscillator will show exactly that, the Stochastics is overbought, which means the market is currently exhausted (at 80 and above) and there may not be more buying until some steam is let off (by moving back to the oversold near 0-20 reading).
So by using these two together, the market action becomes clearer. Let’s take another example.
The chart above shows a Bollinger Bands overlaid on the price chart. Bollinger Bands (timing indicator) shows the extremes of price movements, normally set to 2 standard deviations (upper line, lower line). When prices move and touch the upper line, prices are predicted to reverse and move down and vice versa. Combining this with DMI, we will know whether there is a trend or not or which direction of the trend it is going. Currently the chart shows the DMI lines are converging, indicating there is no trend or that the market is detrending (going sideways). This is the beauty of the combined indicators: keeping you out of the market when there is no money to be made.
Keep it simple is a rule that works well in the markets. Combining the two common indicators can be effective, as long as they are each from different type of indicator. Do more research and make sure to test in the real time to get an idea how the indicators work to avoid confusion and indecision.
