In this post, I will be writing about indicators, types, and importance. It is important to note that some traders do not believe in indicators while others believe in it, Using it is dependent on your preference and the type of trader you are. I use it and it makes my trading easy.
What are indicators?
Indicators are one of those tools that have been mathematically calculated that shows more information about the price on a chart. For example, a 30 day moving average shows the the average price of a currency over the last 30 days, a candlestick will not show you this so easily. This in turn saves you stress of calculating it manually. Technical analysts use indicators to help identify certain patterns in the market alongside the candle stick patterns. It is often used when formulating strategy as this helps with objectivity before executing a trade or before leaving a trade. It should be noted that an indicator is not a strategy as most people make this mistake a lot. You must have heard things like if it is in overbought, it is definitely going down and if it is oversold it is definitely going up. These sets of people will get bitten badly in the markets. An indicator can be likened to a pointer to a traveler's, a torch is not a map. the torch shows you the path but you know the direction in which you are headed.
Types of Indicators?
Indicators are of different types. They can be classified as leading or lagging or as trend-following or oscillators. There is also a group called miscellaneous indicators.
Leading indicators
Leading indicators are indicators that give a signal before the new trend or reversal occurs. This definition looks so good however if it was this easy everyone would be a billionaire from the markets. Leading indicators help identify turning points and start of a trend. They are also called oscillators.
They include MACD-Histogram, Force Index, Stochastic, Rate of Change, Momentum, the Relative Strength Index, Elder-ray, Williams %R, etc.
Lagging indicators
Lagging indicators are indicators that change movement after the trend has already started. They are also called trend following indicators. They include; moving averages(Simple and exponential), MACD Lines (moving average convergence-divergence), the Directional System, On-Balance-Volume, Accumulation/Distribution, etc. They have the downfall of late entry. However, they are confirmed trends.
Importance of indicators.
Indicators serve as a fulcrum to your technical analysis. Like I said earlier, it also helps with objectivity when making a strategy. This objectivity helps you to decide whether a trade is worth entering or not.
Some tidbits on indicators
These tidbits are from my personal views and years of personal study.
- Always test your indicators over a period of time before adding it to your strategy. This, therefore, means you should backtest and demo trade before going live.
- A maximum of 3 indicators should be the aim. Too many indicators on a chart can be very confusing. This confusion tends to cause indecisiveness and hence an increase in fear when it comes to entering a trade.
- One of the indicators may be leading and the next could be a lagging indicator. For example, combining a moving average with a stochastic.
In my next post, I will be talking about the various indicators.