How To Use Indicators In Simple Trading

"Although measuring omega-3 levels in the blood seems like it would be an objective and accurate indicator of fish oil intake compared to using the subjects' reported dietary intake, this test does not accurately reflect long-term dietary intake."
-- Joel Furhman

Nearly all technical indicators technically [see what I did there?] fit into five categories. Each category can be further subdivided into leading or lagging. Leading indicators supposedly predict where price is going while lagging indicators report background conditions when price is already in motion. In truth, I think all indicators based on price behavior and/or volume are lagging as they're all enabled by what price and volume have already done.

At any rate, here are the designations based on the stated false dichotomy:
  1. Trend indicators (lagging) analyze whether a market is moving up, down or sideways over time.
  2. Mean reversion indicators (lagging) measure how far a price swing has stretched before a counter impulse might trigger a retracement.
  3. Relative strength indicators (leading) measure oscillations in buying and selling pressure.
  4. Momentum indicators (leading) evaluate the speed of price change over time.
  5. Volume indicators (leading or lagging) tally up trades and quantify whether bulls or bears are in control.
In reality, the best simple trading use of all price/volume indicators I've ever reviewed [and that's a larger number] is as providers of context as opposed to predictive tools. It's a small, but important distinction.

Most novices follow the herd when building their first trading screens, grabbing a handful of preset indicators and stuffing as many as possible on, over or under the price bars of their favorite securities. They do that because... well... "if 1 is good, 3 must be outstanding right?" Further, their real goal tends to be loss avoidance rather than maximation of the profitability of their trading strategy.

Don't do this. This "more is better" approach short circuits signal production because it looks at the market from too many angles at once. It’s ironic because indicators work best when they SIMPLIFY analysis, cutting through the noise and providing usable output on trend, momentum, timing... CONTEXT.

You're welcome.


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