It is easy to see why retail traders find indicators appealing because of their ease of use and clear-cut signals. In fact, many new traders think they know all about trading because they have learnt a few basic indicators that generate simplistic buy/sell signals. This kind of thinking is dangerous because it shuts them off from learning real trading skills like price action and behavioral analysis.
What are indicators and how are they derived?
There are only five pieces of information we can get from charts: the open, high, low, close and volume. A skilled trader can interpret this in terms of market behaviour of psychology instead of processing it as a bunch of numbers. Indicators, on the other hand, attempt to use shortcut calculations to give meaning to these numbers. As a result, they can never be faster than reading the actual raw data. Manipulating data may also mask its information quality and granularity, causing you to miss out essential essential details.
Do professionals use them?
The answer is minimally. If you go to any bank/fund or professional trading arcade, and observe the traders who trade there, you will notice that their charts are mostly blank. This is not coincidence, because such a chart setup is optimised for reading price action, with as little distractions as possible. If you don’t believe me, go check it out yourself. As said by the famous Leonardo Da Vinci, “Simplicity is the ultimate sophistication.”
The dangers of using indicators without real trading skills
Many traders, especially beginners, are drawn to indicators, hoping that an indicator will show them when to enter a trade. what they don’t realise it that the vast majority of indicators are based on simple price action. Oscillators tend to make traders look for reversals and divergences, and when the market is trending strongly (best chances to make money), they will be repeatly entering counter-trend and losing money. By the time they come to accept that the market is trending, it will be too late to get a good entry to recoup their losses. Instead, if you were simply looking at a blank chart, it would be obvious when a market is trending, and would not be tempted by indicators to keep looking for reversals.
Common heuristics such as “buy when this line crosses this line” or “sell when this is in the overbought region” are some overly simplistic ways of using indicators. Trading in this manner does not give you any understanding about the market. It does not answer the “why” question, such as why this line crossing that line generates a buy signal. Quite often, one may also get conflicting signals from different indicators, and without an understanding of price action, one has no way of resolving the conflict.
Are indicators really needed for your decision-making?
Some pundits recommend a combination of time frames, indicators, wave counting, and Fibonacci retracements and extensions, but when it comes time to place the trade, they will only do it if there is a good price action setup. Also, when they see a good price action setup, they start looking for indicators that show divergences or different time frames for moving average tests or wave counts or Fibonacci setups to confirm what is in front of them.
In reality, they are price action traders who are trading exclusively off price action but don’t feel comfortable admitting it. They are complicating their trading to the point that they certainly are missing many, many trades because their over-analysis takes too much time, and they are forced to wait for the next setup. The logic just isn’t there for making the simple so complicated.
So… Should I be using indicators at all?
The best solution for the retail investor would be to first master a firm foundation of price action and behavioral analysis, and subsequently, should he choose to use indicators, should remember that as their name suggests, they are not “entry/exit signallers”, but merely “indicators”.
Therefore, it is a matter of how you use indicators, and one should always keep in mind that indicators are there to aid you in reading the price action, and not act as a substitute for it. You can think of indicators as the training wheels of a bicycle – you will want to remove them once you learn how to ride properly.
Trading always involves uncertainty, and trying to find comfort in the certainty of indicators will lead to constant indecision, second-guessing and parameters-tweaking.
If you would like to learn how to get started in trading, also check out: “The Beginner’s Guide to Trading & Technical Analysis”
Anchoring and adjustment is a psychological heuristic that influences the way people intuit probabilities. Traders exhibiting this bias are often influenced by their initial opinions, the initial trend, or arbitrary price levels such as their entry or target prices – and tend to cling to these numbers when making their buy/sell decisions.
This is especially true when the introduction of new information regarding the security further complicates the situation. Rational traders treat these new pieces of information objectively and do not reflect on purchase prices or target prices in deciding how to act.
Anchoring and adjustment bias, however, implies that investors perceive new information though an essentially warped lens. They place undue emphasis on statistically arbitrary, psychologically determined anchor points. Decision making therefore deviates from neoclassically prescribed “rational” norms.
For example, traders who are anchored to the initial trend are slow to catch on when the trend has reversed, especially if they are caught on the wrong side of it. This will lead to a reluctance to change their view and reverse their positions.
How will this affect your trading?
Traders who are anchored to price levels, such as their entry price, will refuse to cut their losses until prices go back to the entry price which they have anchored to. Traders may also refuse to take profit at a less desirable price because they missed the chance to take profit at a more favourable price, and they have now anchored to that price and refuse to settle for less.
The key to overcoming this bias is to be flexible and objective, being able to evaluate prices and make decisions objectively, whether you are in, out, up or down.
Every trader knows that using multiple timeframes can provide different perspectives on the market, and provide key information on the lead-lag relationship.
Small timeframes lead larger ones, and larger ones drive the smaller ones. Understanding the inter-play is crucial.
Since trends exist on different timeframes, it makes sense to analyse at least two timeframes.
For example, if one’s main timeframe is the daily chart, one can consult the weekly chart to see the big picture.
This allows investors to analyze a particular trend against the perspective of the next higher timeframe.
If one is using swing counts, a lower/higher high/low in the weekly and monthly charts can provide perspectives not seen in daily charts.
Long-term trendlines may be clearer, and more obvious/easily visible.
Certain price patterns are more visible on long-term charts (key reversals, triangles on weekly), as well as long -term support and resistance levels.
A trend change signal on the short-term (daily) may only be a retracement in the long-term (weekly) chart.
On the other hand, a trend change signal in the long-term chart may be a substantial move in the short-term even though a short-term move may seem overdone.
Hence, an overdone breakout on the short-term trend may actually be the start of a major breakout if the long-term chart is still on an uptrend.
Divergence signals are also more obvious when timeframe is compressed, for example a price-volume divergence is more obvious on the weekly compared to the daily.
Divergences on the larger timeframes also point to larger moves, and could herald major reversals.
The Dual Timeframe Technique
This involves using 2 different timeframes to trade, one to provide the roadmap and the other to time the precise entries and exits.
Strategic Timeframe: This timeframe acts as a roadmap for the execution timeframe, giving you an idea of longer-term trends, hence providing you strategic direction on how to select your setups and manage your trades.
Execution Timeframe: This is your main timeframe for trading, and will be what you are looking at as you decide on your stoploss, entries, and exits. The focus is on precision and timing, so this timeframe is like zooming in from your strategic timeframe.
For example, for my strategies, I use:
- Strategic Timeframe: Weekly chart
- Execution Timeframe: Daily chart
- Expected holding period: Can last for a few days to a few weeks (if the trend is strong)
If you are doing intraday trading, then your strategic timeframe might be the daily chart, while your execution timeframe might be the 5-minute or 15-minute chart.
In conclusion, using multiple timeframes allows one to better identify trends, and more precisely pinpoint entries and exits by zooming in and zooming out from the initial point of reference.
This also allows one to better manage risk in line with one’s time horizon and investment timeframe.
If you would like to learn how to get started in trading, also check out: “The Beginner’s Guide to Trading & Technical Analysis”
Photo with Lee Lung Nien, COO of Citibank Singapore
This year, it was once again a gruelling tough battle at the Citbank Forex Challenge. There were over 300+ teams, and only 48 made it to the finals. I am proud to announce that 4 of the 8 teams from my round that made it to the finals were from the SMU Investment Club, including the top 3. Nicholas and I topped the qualifiers again this year, unfortunately we did not fare well in the finals. However, it was some consolation that the 1st place was taken by a team comprising of my juniors from the investment club. As the research director and trainer, I am glad that the juniors I have trained under the Advanced TA training sessions have managed to perform so well this year.
Free Trading Guides
