How to Combine Trading Indicators (This Separates Professional Traders from Amateurs)

Knowing what indicators to use and what is
the best combination of technical indicators can dramatically improve your chart reading
skills. If you use the wrong technical indicators,
this can lead to inaccurate price interpretation and bad trading decisions. Technical indicators can make it easy for
you to identify current price trends and predict where prices will move in the future and by
developing effective technical analysis strategies, you can increase the amount you earn each
trading day. When it comes to indicators, we can divide
them into four classes: • Trend-following indicators
• Momentum indicators • Volume indicators
• Volatility indicators Trend indicators – trend indicators are
designed to measure the strength and direction of a trend. If a market is in a strong uptrend, a trend
indicator gives you a buy signal, and if the market is in a strong downtrend, trend indicators
give you a sell signal. However, since indicators are based on past
price-data, most trend indicators lag the price and give trading signals after a trend
has already been established. This means a trader will likely miss the initial
move of a new trend until a trend indicator sends a trade signal. Popular trend indicators include moving averages,
parabolic stop and reverse (Parabolic SAR), average directional movement index (ADX) and
the moving average convergence divergence (MACD). Momentum indicators / oscillators – another
popular group of technical indicators are momentum indicators, also called oscillators. Unlike trend indicators, oscillators measure
the relative strength of recent price-moves and plot a value between 0 and 100 – hence
their name. If prices are rising strongly, an oscillator
follows and reaches overbought levels, giving you a sell signal. Similarly, if prices are falling, an oscillator
reaches oversold levels and sends a buy signal. Oscillators work extremely well in ranging
markets but lead to whipsaws when markets are trending. Popular oscillators include the relative strength
index (RSI), stochastic indicator and momentum oscillator. Volume indicators – volume indicators measure
the strength of a price-move by using the information of trading volume. While volume indicators are very popular among
stock traders, forex traders can’t take much advantage of them since there’re no
reliable measures of trading volume in the currency market. Popular volume indicators are the Chaikin
Oscillator and on-balance volume (OBV). Volatility indicators – as their name suggests,
volatility indicators measure the rate of price-changes regardless of their direction. Volatility indicators rise when markets are
fast and fall when markets are slow. Popular volatility indicators include Bollinger
Bands and the average true range (ATR). As you can see, while these categories of
indicators are trying to determine the same thing—whether prices are about to increase,
decrease, or remain stable—the angle they each offer is unique. Looking at the market from multiple different
angles can help you develop a more accurate, realistic, and actionable perspective. Knowing which one belongs to which category,
and how to combine the best indicators in a meaningful way can help you make much better
trading decisions. What you need to realize is that, while all
technical indicators are useful, they each have their own set of weaknesses. And, combining indicators in a wrong way can
lead to a lot of confusion, wrong price interpretation and to bad trading decisions. The biggest problem with traders is the fact
they use different indicators which belong to the same indicator class and then show
the same information their charts. If you take a look at this chart, we added
3 momentum indicators (MCD, RSI and Stochastic). Essentially, all 3 indicators provide the
same information because they examine momentum in price behavior. You can see that all indicators rise and fall
at the same time, turn together and also are flat during no-momentum periods. So, if you trade with a multi-indicator strategy
that uses the RSI indicator, MACD indicator and the stochastic indicator you are basically
using 3 types of technical indicators that belong in the same category. These are all momentum indicators that are
going to display the same kind of information in one way or the other. Another common mistake is using only trend
indicators. This example shows a chart with 3 trend indicators
(Parabolic SAR, moving averages and Keltner channels). Again, the purpose of these indicators is
the same: identifying trend direction. You can see that during a trend, all indicators
are practically indicating the same thing. At the same time, during ranges, they all
offer bad signals. I hope you see the problem with adding multiple
indicators showing the same information, you will end up giving too much weight to the
information provided by the indicators and you can easily miss other crucial things. You might use 2 or more trend indicators and
you might believe that the trend is stronger than it actually is because both of the indicators
will give you the green light and you might miss other important clues on your charts. The problem with using unfitting technical
indicators is that you might actually think the trade signals are stronger if all indicators
point in the same direction. And this is completely wrong! The fix to the over-emphasizing information
from using indicators that belong to the same group is quite simple. Avoid using technical indicators that display
the same kind of information. The best strategy with multiple indicators
combine indicators that show a different type of information. And here’s another common mistake: using
way too many indicators. Tell me if this sounds familiar: you find
a strategy or an indicator on a forum or here on Youtube. You decide to back test it on a demo. You take a look at your charts and spot a
few good entries. The only problem is that it’s missing something…
yes, a few more indicators, filters to keep you out of bad trades. What can you do? There’s only one answer: add more indicators. But which one? No problem, you open your trusty folder of
indicators and start trying out different ones. You back test again: now the strategy gives
better results… but still you have some losses and since you are on a quest for the
Holy Grail, you add another “filter”…. And another… and another, until you realize
your charts start to resemble a Christmas tree. And now you’re more confused than ever. Some indicators say “short” while others
say “long” and by the time they all agree, price moved 50 pips and it’s too late to
enter. What’s worse, you realize you started with
a potentially good strategy and modified it almost completely. I suffered from the same problem, don’t
worry. We all did. You don’t need to clutter your charts. Less is more. You might still have a strong belief that
each indicator on your chart serves an essential purpose and you cannot trade without all of
them. You don’t need to transform yourself into
a price action trader, but if your results are not great, get rid of some indicators,
you’ll see that your mind will be more active and you’ll start to analyze price movement
from a different perspective. • So, limit your use of indicators to 2
or 3 max (preferably 2). • Do not try to filter out all losing trades
with the use of indicators. You’ll end up filtering out the good trades
as well. • Don’t just add a new indicator after
a loss because losses will occur even if you use 100 indicators. • Let indicators confirm your trade bias
and don’t follow them blindly Now, here are several combinations of indicators
that you could use: 1. One trend indicator and one momentum indicator
You could use a moving average to determine the trend, and the stochastic for example
for confirmation or as an entry point. If you watched my stochastic video, you already
know that I like to use the 200 EMA to identify the trend, and I use stochastic to find divergences
in the direction of the primary trend. When the price is above the 200 EMA, I plan
to take long trades, when the stochastic show a divergence, and when the price is below
the 200 EMA, I take short trades based on the same divergences offered by the stochastic. 2. You could use a volume indicator and a trend
indicator I prefer to use the OBV in combination with
the moving average. My personal preference is to add a long-term
moving average on the on-balance-volume. This helps me to determine the direction of
the trend – as this crossover offers an excellent outlook on the prevailing trend
on the market. When the OBV is above the moving average,
i search for long positions, in the direction of the main trend. When OBV is below the moving average, I take
only short positions. 3. A volatility indicator and a momentum indicator
is also a good fit. I like to use the Bollinger bands and the
RSI indicator, to search for divergences when the Bollinger bands are flat. You can use any other indicators. What type of indicator you decide to use to
develop a strategy depends on what type of strategy you intend to develop. This relates to your trading style and risk
tolerance. If you seeks long-term moves with large profits,
then you might focus on a trend-following strategy, and, therefore, utilize a trend-following
indicator such as a moving average. If you’re interested in small moves with
frequent small gains, you might be more interested in a strategy based on volatility. Again, different types of indicators may be
used for confirmation. Traders often talk about the Holy Grail – the
one trading secret that will lead to instant profits. Unfortunately, there is no perfect strategy
that will guarantee success for each investor. Each trader has a unique style, temperament,
risk tolerance and personality. As such, it is up to each trader to learn
about the variety of technical analysis tools that are available, research how they perform
according to their individual needs and develop strategies based on the results. If you got any value from this and learned
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