Using Technical Indicators to Improve Your Trading

One of the most difficult aspects of trading and investing is selecting appropriate technical indicators and whilst all technical indicators will work some of the time none will work all of the time. With over 150 to choose from, and more joining the market every day, it's not surprising that traders and investors can feel both confused and overwhelmed. However, understanding and knowing which indicator to select and apply to a particular market and time frame will be the difference between success and failure. It is my belief that the best way to approach the use of indicators is as follows:

First, understand that the most important technical indicator is the price on a chart, what lies behind it, where is it likely to go (up, down or sideways) in the short, medium and long term. For the purposes of this article whenever price is mentioned it is based on the use of Japanese candlesticks although there are other formats such as, point and figure, Renko etc.

Step one is therefore to start with a chart. Next is to select the time frame best suited to your own personal trading and investing strategy. As a long term currency trader my own time frames are monthly, weekly and daily. Minute by minute movements in currency pairs are of little or no use at all. Similarly equity investors would look at end of day data through to yearly charts in order to see how the price has been moving. On the other hand as day and swing traders are only interested in making a profit as fast as possible they will use anything from minute to hourly charts. All this is self evident yet why do so many fail in the financial markets?

The next stage is possibly where it all goes wrong when perhaps too many inappropriate or conflicting indicators are added to the price movement and time frame. Avoiding these mistakes is actually quite straightforward and the key is it to keep it simple. For novice traders I would suggest starting with the simplest indicators of all, namely volume and simple moving averages. Volume will give you an idea of how many traders are joining in the move, either up or down, and all charts now include this within their packages. Look for anomalies in the volume such as very large volume spikes which stand out from the average, and conversely very small volume, where you might expect average volume to appear. These signals will indicate that perhaps something is happening in the market and we need to pay attention.

Simple moving averages, as their name suggests are moving averages are simply an average of previous price movements. They are excellent for identifying turning points, where we are looking for crossover points, with one crossing over another. Personally I set these up using a 20, 50 and 200 period MA. Here I look for the 200 crossing the 50 for a possible trend reversal downwards, and the opposite for an uptrend. In addition I look for prices to bounce off the 50 SMA as this indicates strength in the upward trend. Simple moving averages are very easy to set up and again all trading packages will include them as standard.

Other indicators can then be added to this basic setup and here I would suggest adding one at a time and testing its effectiveness under different market conditions. It will be a case of trial and error and keeping things as simple as possible which is at odds with the powerful trading packages and black box systems so readily available. However, the analogy I would use here is a mobile phone, yes it can take pictures, play music and surf the net but actually when you have broken down in your car and you need help all you want is to be able to make a phone call for help!

Anna Coulling