This article on How to Select the Right Technical Indicators is the opinion of Optimus Futures.
Most traders’ endeavors and their learning curves involve at least a few periods where they have been obsessed with technical indicators. It is a rather intuitive and natural progression, albeit a potentially costly one. As technical traders explore the realms of technical analysis, the fine line between having enough indicators that aid in decision making versus having far too many can often be unintentionally crossed.
While trading naked charts (i.e. without indicators) is not always advisable for newer traders who can benefit from following some of the useful technical indicators, it is perhaps just as ineffective by polluting your charts with multiple indicators that erode the simplistic nature of everyday chart analysis.
Let’s take a look at some of the categories of indicators that you should be considering when selecting your arsenal of technical indicators for your everyday chart analysis.
If you are going to use technical indicators, choosing one that helps you spot trends more easily and objectively can be very beneficial.
There are many popular trend indicators you could potentially pull up on your chart, but before you get too excited, we would like to emphasize the importance of keeping it simple. It is good idea to perhaps choose one that you seem to be most comfortable with and which seems intuitive to use.
Moving averages is a great example of a popular trend indicator. Pulling up some moving averages on your charts usually allows for additional potential support and resistance levels right at your eye line, and when slow and fast moving averages are plotted together, they can serve as potential warnings of momentum exhaustion or a potential trend change.
As the category name suggests, moving averages among other popular trend indicators usually work best in trending market situations where they help in gauging the overall strength of the trend. We now look at another group of indicators that help gauge momentum in often sideways trading environments and periods of consolidation.
Oscillator indicators use current and past price levels as inputs to a program that plots moving lines, usually within a set range of values (upper and lower limits) often with a center line.
Some common oscillator indicators include the MACD, the RSI, and the Stochastic indicators, that technical traders employ either independently or as part of a broader trading methodology to gauge short term momentum and temporary periods of overbought and oversold conditions.
Points of interest for most of these oscillator indicators appears when the lines come in close proximity to either the upper or the lower level indicating a buildup towards either an overbought condition or an oversold condition. This in turn helps traders determine potential trading opportunities by often foreseeing a change in momentum more conspicuously than pure price action will sometimes reveal. We therefore believe that an oscillating indicator is a definite good addition to a technical trader’s arsenal.
Notably, because oscillator indicators are tied closely to live price action, they often add a new dimension to technical analysis, especially in a sideways market that may otherwise be hard to analyze, particularly for newer traders. The swift changes in momentum can often coincide with clear markings on the RSI or the Stochastic being in overbought or oversold conditions while movement above and below the zero line on a MACD can sometimes be very telling of a clear shift in market sentiment.
Oscillating indicators additionally serve as concrete tools to gauge conventional bullish and bearish divergence. Being a direct indicator for momentum, higher highs on the price chart matched with lower highs on for example the RSI or the MACD can be tell-tale evidence of bearish divergence – or rather a slowdown from the buyers in the market.
As a technical trader, the choice of the market or markets that you plan on trading can be a very important decision. And that decision may often hinge on the liquidity of the considered market and perhaps the volatility itself.
Volatility of a market is a gauge for the price range that the financial instrument normally trades in. As a technical trader you want to avoid market situations where the volatility is too low (small candlesticks, tight range bound market conditions) as well as instances where the volatility is too high (periods of news announcements or illiquid periods of trading that can bring about sharp price movements in either direction). Keeping a tight watch on the state of the market is very important for an informed technical trader which is why we believe adding a volatility indicator on your chart may be a very good idea.
Again, like other categories of technical indicators, volatility indicators can be found in good numbers too, often as free add-ons for trading platforms. We however recommend selecting among the common ones which include (but are not limited to) the Volatility Index (VIX) used most commonly as a gauge for volatility in the S&P500 index and derivative instruments, the Average True Range (ATR), and the Bollinger Bands.
The Volatility Index, while an indicator, is unique in the sense that it can also serves as a trade-able futures market in itself too. However here we refer to as a technical trading tool to gauge overall market activity and volatility levels.
The Average True Range directly measures market volatility by decomposing asset price levels over a certain period of time and is one of the most powerful and simple indicators to use. Higher readings on the indicator prompt higher volatility levels while lower readings indicate stable market conditions or periods of low volatility.
Bollinger Bands provide similar information, except that the indicator gets applied directly on the price chart where a couple of moving averages “wrap” around current price levels to indicate periods of low or high volatility.
As you may expect, this indicator can be great additions to a breakout trader’s arsenal. The tightening of the bands around current price levels allows the trader to foresee the possibility of a pressured situation that could be building towards a breakout.
Carefully evaluating and selecting the group of indicators you will be using for your day to day trading an chart analysis is potentially the centerpiece of a sound trading methodology that not only keeps the art of reading price action simple and straightforward but also avoids some of the major bottlenecks and challenges that new traders often face – such as over trading, and over analysis (analysis paralysis).
While trading without technical indicators can be an advanced approach best suited to professional traders, loading up your charts with colorful indicators, histograms and lines does not help much either. In the article above we highlighted the few major categories of indicators we believe you should consider selecting from in order to deploy an all-rounded set of technical indicators on your charts for profound analysis.
There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.