Education

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?

Criticism

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.

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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.

Tips

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. 

Conclusion

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. 

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