Continuing on with my trading journey, I came across a Technical Analysts group and joined that to find out more about trading and to increase my knowledge. Being a Technical Analysts group there was a major focus on price action combined with a multitude of indicators and the theory behind it. The amount of indicators and breath of knowledge to learn seemed endless. So began my quest for trading knowledge.
The most commonly used technical indicators can usually be broadly categorised as either trend following indicators or oscillators. They can be as simple in their calculation as a moving average or as complex as a stochastic oscillator. Some work well in trending markets and others when markets move within a range.
There are so many indicators that together they can take a long time to learn and understand due to their abundance. Beginning traders often go down a path initially where they incorporate more and more indicators into their trading strategy in an effort to achieve their desired results, particularly when back testing trading systems.
Many indicators need you to set a variable for the length of the period or some other user defined length. If a system includes many indicators, each with their own variables, there can come a point where the system becomes over-optimized. When this occurs real trading results almost certainly disappoint compared with the tested results, especially if the results vary widely with a change in the variables used.
Knowing everything there is to know about indicators will fill your head with a lot of useless information that may lead to confusion. Ensure that you have a valid reason for each technical indicator used and that they are not duplicating one another.
Whilst it is important to have some knowledge of technical indicators for most styles of trading, keep in mind that simple trading concepts work. A good trading system should make sense when you explain its components in words.
- What do the indicators that you are using mean? Explain them in words.
- Are there duplications in your trading strategy? That is, several indicators all doing a similar thing?
- Do the user defined variables make sense and are they appropriate for your system. That is, is the period length representing a month, day, week, hour or some shorter period? For example, 22 day candles for a month, 12 five minute candles for an hour.
- How many user defined variables are used within the system leading to a multitude of possible results?
- How sensitive are the results to the user defined variables used in the indicator? Try changing them +/- 1, 2 or more.
- Are there a few outlier trades in the results, that if excluded would mean that your objectives wouldn’t be achieved?
- Explain your whole system in words, saying what each indicator means and giving reasons why the user defined variables you have chosen are appropriate in the context of your system.
The more your system and its components make logical sense, the less you need to rely on back testing to have confidence to trade your system.
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About the Author: I’m Rachel Hunter, TraderRach, a Forex Trader who helps traders achieve the life they love with forex. Be strategic and design your trading business for sustainable success and have fun! That’s my mission. Join many traders’ gaining the edge with “10 Powerful Lessons for Forex Trading Success” plus other goodies. Years of precious learning specially packaged up for you. My background before trading is as a Chartered Accountant and Chief Financial Officer. I know what it takes to make a trading business rock on. It would give me great pleasure to make a difference to your success.