technical analysis

Right way to use Technical Indicators

Daksh Murkute | | |

Indicators seem very simple, right? It’s just based on math formulas and in return it gives buy and sell signals that we can easily trade based on it.

 

I have come across so many traders that have built their trading strategies just on indicators and seem to do pretty well for themselves, but still, many people claim that indicators don’t work. Let me tell you that’s not really the case.

 

The main issue is that traders just use indicators in the wrong way and that ends up costing them not just lost opportunities and time, but also money and they go on to blame the indicators for it.

 

In this blog post, I’m going to tell you how you should be using indicators and what the right way to trade is based on a combination of indicators so that you don’t get wrong trade signals and that you don’t unnecessarily lose money on them.

Contents

 

 

Different types of indicators

 

Different types of indicators - Trend, Momentum and Volatility Indicator

 

I’m sure that you know a couple of indicators. Some of the most commonly known indicators are moving averages, RSI, Bollinger bands, etc.

 

But, if we were to categorize these indicators then you’ll see that each and every indicator falls into mainly 3 categories.

 

Now, if you want to know the right way to use indicators in trading then you should know at least a little bit about these 3 categories and also some of the indicators that fall under these categories.

 

1. Trend indicators

The price, at any point in time, is either going to go up, down, or even sideways. Trend indicators allow you to identify the direction of price movement.

 

The most commonly known and the most widely followed trend indicator is the Moving Average. The Parabolic SAR indicator is also a decent trend indicator.

 

Now, one area where these trend indicators fail is when the price is neither moving up or down and is just stuck in a range. So these indicators will not work 100% of the time and are not any holy grail.

 

 

2. Momentum indicators

These indicators will help you see how fast the price is moving. You can use it to know how strong the price move is and also, how weak it is.

 

These indicators mostly oscillate between two levels and once its value reaches the extreme levels, we know whether the price is overbought or oversold.

 

Obvious examples of momentum indicators would be the RSI and also the Stochastic indicator.

 

 

3. Volatility indicator

In a nutshell, the volatility indicators allow you to understand how stable or unstable the price is.

 

If the price is moving quickly, irrespective of the direction, the volatility indicators will have a high count. While, if the price is kind of quiet and isn’t moving in a haphazard manner, then the volatility indicator will have a low count.

 

Bollinger bands and ATR are two very commonly known volatility indicators and you can use them in trading too, they’re that easy to understand.

 

 

How you should be using indicators

 

How you should be using indicators

 

Now that you know about the different types of indicators and what purpose they serve, it’s time for you to know the right way to use the various types of indicators that are available to us traders.

 

It’s as simple as this, you should use indicators only for that specific purpose that it was built for.

 

If you are using moving averages then use it only to understand what direction the price is moving in.

 

If you are using Bollinger bands then use it only to know how volatile the price is and not to know the price momentum or anything else.

 

I have seen many traders use indicators for the wrong purpose and this leads to them getting the wrong trade signals which further leads to losses only.

 

It is very easy for traders to get swayed by their psychology and other pre-conceived notions in trading and they end up making rookie mistakes, but if you want to get ahead of the rest, then you need to at least get the basics right.

 

If you use indicators for purposes that they weren’t even built for in the first place, then you are never going to get good trade signals and to me, that’s just not worth it.

 

But now, should you use only one indicator at a time? Not really, you can use more than 1 indicator at the same time. But, there are things that you’ll need to keep in mind for that too.

 

 

How you should combine indicators to get good trade signals

 

How you should combine indicators to get good trade signals

 

I have seen traders apply both the RSI and the Stochastic indicators on the chart, and they keep looking for trade signals.

 

Now, this might seem fine to you but let me tell you one thing, this isn’t how you should be using the indicators. That’s because, both indicators are of the same type, both are momentum indicators.

 

This will only lead to you getting the same signals may be at a different point in time, but ultimately you’re trading only based on momentum.

 

One problem that this type of combination would have is that you won’t be able to decide which indicator signal you should stick with, and in the end, it’s just going to get messed up.

 

Now, what if I told you that you can have the better of two things at the same time? What if you used a trend indicator along with a momentum indicator? Won’t that be a better approach? It might just be.  

 

You can use a moving average along with the Stochastic indicator and this will allow you to know the direction of the price move as well as how strong the move is. Isn’t that just great!

 

Along with these two different types of indicators, you can throw in the Bollinger bands to gauge volatility and you can select which currency pair is volatile enough for you to trade and which is not.

 

Now, with all these indicators, you can make many combinations and look for trade signals, but just remember one thing, don’t have the same type of indicators on the same chart.

 

One more thing, I have mentioned above that you can use 3 indicators of different types at the same but it doesn’t mean that the more the better.

 

All I’m saying is that the combination of the indicators is what matters and not the number of indicators that you use. So be careful with what you’re going ahead with.

 

Now, if you’re having indicators of the same type, then you might just end up giving that particular thing much more weightage and you might miss out on other important things that should’ve got your attention.

 

 

Some indicator combinations that you can use

I am hoping that you have read this blog post carefully and with complete attention till now and you have understood how exactly you should be using indicators to trade.

 

But, even if you are still struggling to understand which indicators to use and which combinations should you look at then don’t worry, I’ve got you covered.

 

Here are some indicator combinations that you can try out on your own and see how it works out for you.

 

But wait, I want to give you a disclaimer already, all that I’m going to tell you further are just combinations and not complete strategies.

 

You should just understand the purpose and concept of it and then go on to the charts to backtest it. If in the end, you like the results you get, then only trade live with it.

 

1. Moving averages and RSI

 

Moving averages and RSI

 

Two of the very commonly known and also commonly used indicators in trading, moving averages and the RSI.

 

Now, if you were to use these two indicators, then you are essentially going with a trend indicator and a momentum indicator, which is a decent combination.

 

A rough trade setup using this combination would be to look for only long trades if the price is above the moving average and only short trades if the price is below the moving average.

 

To get entry signals, you can use the RSI indicator and I’d suggest that you have a look at RSI divergences for that, you might find it a good setup to trade.

 

 

2. Stochastic and Bollinger bands

 

Stochastic and Bollinger bands

 

Another decent indicator combination would be to use the Stochastic indicator along with the Bollinger bands.

 

With these indicators, you’ll get to gauge volatility along with momentum and you can get sniper entries whenever there is a strong price move in either direction.

 

A rough trade setup using this indicator combination would be to wait for the price to close out of the Bollinger band which indicates that the price is overstretched.

 

Once you get that, you can look for the Stochastic indicator to get out of the overbought or oversold region indicating a price reversal or something.

 

Again, this isn’t a complete strategy that you should trade right away. I’m just giving you an idea that you can validate by testing it yourself.

 

 

3. Moving average and Bollinger bands

 

Moving average and Bollinger bands

 

Well, if you’re fed up with me giving you only setup ideas and you want a proper setup then here’s one for you.

 

I had come across a trade setup that was based on moving averages and Bollinger bands and I am in the process of backtesting the strategy.

 

So how this strategy works is that we need the price to be either above or below the moving average to establish our bias.

 

Then for trade signals, we would wait for the price to close outside the Bollinger bands, and then we would have a method to get into the trade.

 

Now, you can come up with a strategy of your own based on this hypothesis or if you want to learn a ready-made strategy that is backtested extensively then you need to be attentive to my blog post space as well as my YouTube channel on which I’ll upload the strategy soon.

 

 

What do you think?

I would like to know your opinion on all that I have spoken about in this blog post and how do you use indicators whenever you trade? Do you trade them in a different way and how?

 

Don’t forget to share this blog post with others and let them also learn the right way to trade indictors and get good trade signals most of the time.

 

You can always reach out to me with all your questions and doubts through the comments section below and I’ll make sure that I get back to you at the earliest.

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