Technical indicators: Friends or foes?
What can technical analysis do for you
Whether to use technical indicators or not is a question that creates great controversy among forex traders. Many traders who relied on technical indicators felt betrayed at some point - by a wrong entry signal or a late exit from the market.
As a result, there are those who respect only price action. At the same time, other traders persistently keep looking for a perfect indicator that will bring them tons of profit. Where does the truth lie? Should we bother with technical indicators?
Technical indicators are usually blamed for lagging behind the price. For example, a moving average didn't turn down even after a selloff. In addition, as the current price is always changing, the latest readings of an indicator will change as well making it impossible to use them as any kind of reference.
Learn More About Technical Analysis & Strategy
Finally, technical indicators have a nasty habit of sending you mixed messages you can have
trouble interpreting. One indicator can point at a sell trade, while another will call for buying.
Need for realistic expectations
The truth is that you shouldn't have inflated expectations about indicators because their purpose is not to give you an automatic way to make money. Indicators are there to do calculations and visualize their results so that you don't have to perform these mathematical operations yourself.
It's necessary to have a clear understanding that indicators are derived from the price chart and thus do not offer any external information. Remember this and you'll get cured from wanting too much from the indicators.
In short, indicators:
- make market analysis quicker;
- show things you may have missed otherwise;
- help to form a trade idea.
The course of action should lie in acknowledging the weaknesses of technical indicators and using their strengths.
First of all, notice that there's a different logic behind the formulas of different indicators. There are several types of indicators. Trend indicators help to identify and follow a trend. They won't be of much help during the sideways market.
Oscillators are good in showing the current phase of the market and measuring the strength of its driving force. They can be used during ranges to locate the points when the price is about to turn towards the middle of the range. They can also pick up the moment when the current trend impulse is fading.
If you want to make trading decisions on the basis of indicators, you will need several indicators for filtering out the bad signals and confirmation of the good ones.
From the various indicators that exist, we prefer the good old classics (though there's always room for experiment). Let's go through some things to consider.
Moving averages identify the direction of a trend, act as support and resistance and help to find the moments of trend reversals. Different types of MAs differ mainly by how much weight is assigned to the recent data. Simplicity can be a merit, so if you want a benchmark used by many traders pick a simple moving average. To analyze the long-term trend, use 200-period MA. For a short-term trend, 20- and 50-period lines will be good.
Bollinger bands indicator allows foreseeing spikes in volatility (the bands get closer together). In addition, they may be successfully used with candlestick patterns (look for reversal patterns at the upper/lower bands). Apply the bands during flats.
MACD indicator shows when the market gets overbought/oversold and will need a pause. It can generate a number of hints for traders, the best being the crossovers between the histogram and the signal line. In addition, hunt for divergences between MACD and the price: it's a good indication of a correction to come.
Ichimoku indicatoroffers an opportunity to make a judgment about the market with one glance (that's what its Japanese name suggests). It may look complicated but even beginner traders can use at least some of its features, for example, estimate the power of bulls/bears on the basis of the Cloud's thickness or locate support/resistance levels.
An indicator will show what it's programmed to show, no more no less. If a calculation made by a particular indicator is necessary for your analysis, it's wiser to use this indicator than not. If you want to have an indicator-based trading system, you will need to use several indicators as a single indicator probably won't produce sustainably reliable signals.