Technical trading indicators are there for a reason. Each and every one that you will come across is designed to help traders in a specific aspect of their activity. Some help predict price action, others track volatility to generate buy and sell signals, third help identify support and resistance levels, and more. While all of the different tools can be of help depending on your situation and trading needs, there are some types of indicators that you should be looking to avoid.
What Indicators Should You Avoid Adding to Your Trading Strategies?
If you are looking for a list that shames some of the most popular technical trading indicators, then this guide won’t be your cup of tea. All indicators have a specific purpose and can improve your trading strategy. However, if applied incorrectly, they can backfire by generating misleading and false signals.
To avoid ending up in such situations, traders (beginners in particular) should make sure to stay away from the following types of indicators (at least in the beginning):
Indicators Not Suited to Your Trading Strategy or the Tradable Asset
As you probably know already, there are various types of indicators. The most popular include trend, momentum, volume, and volatility indicators.
The key to building the ultimate trading strategy is simple. First, you want to classify trading indicators according to their purpose. Next, use the appropriate trading indicators for the right purpose.
When you design your trading strategy, it is essential to adopt only indicators that align with your trading goals and profile. For example, a short-term trader like a scalper or a high-frequency trader won’t care about long-term indicators. Instead, they will focus on momentum and/or trend indicators to get a more accurate representation of the current market situation. Also, if you are an investor looking to profit for the long-term, there is no point in putting too much weight on the role volatility indicators play in your trading strategy.
It is also essential to avoid using multiple trading indicators of the same category (e.g., a couple of momentum indicators). Instead, make sure to equip your trading strategy with indicators from different categories.
Also, make sure to avoid adding indicators that aren’t well-suited to the assets you are trading. For example, if you are trading bonds or an asset with a relatively stable price (e.g., gold), then volatility indicators will give you little to no value at all.
Case Against The “Silver Bullet”
There are hundreds of articles discussing “the best technical trading indicator.” However, most of them don’t tell you that no indicator is the undisputed best. Holy Grail indicators don’t exist. Avoid trusting indicators that are said to take you to the “promised land.” If there was a unique technical indicator that guaranteed a 90% or 100% success rate, everybody would have been using it. Were that the case, there simply wouldn’t have been any point in trading the markets.
However, there are indicators that are best for particular use cases or purposes. For example, if you want to identify a trend, you can use Moving Averages or the MACD. If you want to determine overbought and oversold price levels, you can consider using the RSI or the Stochastic Oscillator. You can use Bollinger Bands to get a sense of the volatility. If you want to mark out the support and resistance levels, then the Fibonacci Retracement is a good choice.
As you can see, all of the most popular indicators have a specific purpose. None of them, however, can serve all purposes at once.
Also, to get closer to the idea of the “Holy Grail” indicator, don’t think of using just a single tool. Instead, find the right combination of indicators. For example, a leading one like the RSI can work greatly with a lagging one like the MACD. That way, you can have a system that alerts you before the opportunity arises and also confirms it afterward. Alternatively, you can also combine a momentum (RSI) with a volatility indicator (Bollinger Bands). Doing so lets you measure different data points and get a more precise signal. In that sense, the idea of the “Holy Grail” indicator can work only if it is a system of tools. Not a single indicator can do it on its own.
Other Traders’ Custom Indicators Promising High Win Rates
There are all types of trading setups, indicator packages, or advanced tools for sale on the internet. The common thread between them is that they promise high win rates and an “optimal” formula for solving the markets.
While these indicators might, indeed, prove very effective, there is a catch – they are designed for specific purposes. This purpose might often be different from what you are trying to achieve. Consequently, they’re unfit to work all the time and in every trading setup.
Blindly copying the indicators that other traders use is a recipe for disaster. There are several reasons for this. First, you aren’t familiar with the indicator settings of other traders since you have no idea what their indicators are used for. Thus, there is no guarantee the particular setup will work in your case.
Next, markets aren’t a vacuum. Just the opposite – they evolve and are in continuous motion. Bear in mind that these “high-winning” trading setups are usually built from scratch and tested over time to work over specific settings and market conditions. But what happens when the market conditions change? Would you be able to react, or would you rely on the same strategy to give you a way out?
High-performing strategies aren’t some unique combination of indicators or settings. They are successful since the traders using them know how to react in every situation. That is why relying on a single indicator or a group of indicators to take you out of trouble or help you catch only the winning trades isn’t a viable strategy in the long term. You should make sure to learn how to switch gears and when to apply the different tools in your arsenal based on the dominating market conditions.
Indicators without a Purpose
The fear of missing out (FOMO) is a common perception among traders. For example, if you are trading with a 60% success rate, but you see that a friend of yours or another trader you met online is hitting a 70% – 75% success rate, you will want to know what he does better, right? And you notice that they are using an indicator you aren’t. However, bear in mind that this indicator is more likely not to be the reason the other trader does better than you. And there is no point in throwing it into your strategy as well since you won’t know what to do with it.
The first and most important thing is to ensure that every indicator you have on your chart has a purpose. The second is that you have only one indicator for each purpose.
For example, a trader who thrives in periods of higher volatility doesn’t have to use several indicators to track it. Just the opposite – a single indicator is enough for the purpose. Don’t forget that indicators from a single category are correlated. The reason is that they’re based on pretty much the same fundamentals. Thus, they will give you similar signals.
Furthermore, using a single indicator to track volatility leaves room to equip your chart with momentum or trend indicators that can enhance the other aspects of your trading strategy. The only thing you will achieve by adding many indicators to your chart is introducing more noise. Alternatively, you will make the chart harder to interpret.
New Indicators
You have to remember that technical analysis is three centuries old. Many indicators that sprung up 50 or 70 years ago remain some of the most popular and effective ones to date. That is why you can always hear that technical indicators are like wine – they get better with age. And with all the talk about how evolved and complex financial markets have gotten today, one thing remains the same – the oldest technical trading indicators continue to work perfectly even today. The reason is that fundamentals don’t change.
However, nowadays, traders run in herds to come up with new or “improved” versions of time-tested technical trading tools. This isn’t necessarily a bad thing since many of them are designed in a way to reflect the new and dominating realities and market behavior. In that sense, this isn’t to say that these refined versions or entirely new indicators aren’t worth exploring. It is just that it takes years for an indicator to prove its worth, as well as the repetition of several market cycles.
It is essential to avoid using indicators that don’t have sufficient market history. In the end, you will be risking your own capital by basing your strategy on something unproven. Again, don’t forget that what we currently have as trading tools is more than enough to help you build a well-performing system. The difference these new indicators or the refined versions of old ones will make won’t be so significant. The risk, however, might be.
To Wrap Up
Do you think it is a coincidence that indicators like the RSI, Stochastic, MACD, Bollinger Bands, Fibonacci Retracement, and a dozen others are the most common ones? It isn’t. With trading, as with anything else, starting with the basics and with what has proven its worth over decades and various market conditions is your best shot. There is nothing wrong with wanting to try and test new things. Trading platforms such as NinjaTrader® and Finamark offer a variety of different indicators for traders to experiment with. However, be aware of the risk you will be taking. In many cases, they won’t be worth it.
