A Practical Use of Technical Indicators

As an instructor with Online Trading Academy, I distinctly remember how I felt when I was learning all about support, resistance, trends and all the other aspects of traditional technical analysis. Now I am on the other side of the room, I use my own experiences to teach my students in a practical manner. This simplifies the complications and frustrations of FX trading into an approach which is easy to understand. This approach steps over traditional technical analysis, and instead focuses on pure price action in terms of raw supply and demand that has been created by the biggest banks and institutions. If we can learn to follow the footsteps of the biggest market players, the need for any other tools is erased altogether. Buying when the markets show demand and selling when they show us supply will always trump any other form of technical pattern or indicator.

In the world of technical trading we have both patterns and indicators. When I first started to study trading I loved the idea that an indicator would tell me when to buy and sell! It seemed so easy…today it fascinates me how much importance I placed on technical indicators. In the search for the perfect prediction tool, I went from one to another in a desperate attempt to increase my success rate and earn more money from the market. What I failed to understand however, is that indicators are very far from the be-all and end-all of consistently profitable trading. My message for this article is that we all need to remember that any technical indicator is nothing more than a decision support tool, rather than a decision-making tool, and will always lag behind price.

No matter what your indicator of choice may be, they are all a derivative of price itself. All indicators are created with the data which price provides and are only going to give the trader a buy signal after price has started to rally or a sell signal after price has already fallen. This creates a potential trap for the novice as it forces them to buy late or sell late, often missing the move and resulting in another loss. Instead of just relying on the indicator to tell us what to do, we can instead focus on the behavior of price and use the technical tool as a further confirmation vehicle to build our confidence in the position we have taken, in conjunction with a primary decision-making tool, like a zone of supply or demand. For this example, let’s look at some recent intraday action on a chart of GBPUSD:

I have attached a Slow Stochastic Indicator with its basic default settings. As you may already know, the upper and lower green lines at 80% and 20% represent conditions of Overbought and Oversold respectively. Should the Stochastic cross into and leave these areas, we are given buy and sell signals for trade opportunities. Notice how we had 3 failed sell signals, mixed with some signals which did worked out a little? Even though the indicator was saying we should sell, the market continued to rise. So, how can we avoid this scenario and use the indicator to give us a real odds enhancer instead? The answer is simple: combine it with the best indicator of all, namely price.

By respecting the unbreakable laws of supply and demand and combining this with the sentiment of trend, we can get a far better feel for high probability trading opportunities. The Stochastic should ideally be used in conjunction with the supply and demand dynamic, along with trend, to make for a powerful combination. See the same chart below:

As you can see, when GBPUSD hit price demand zones, we still got the very same buy signals from our indicator but with far better results, especially as we looked to follow the trend as well; which meant we ignored sell signals while the market was rising. In effect, we ran a filtration process in our analysis and looked for a confluence between the technical indicator and price itself by using our demand zones and the uptrend as the primary reason for getting into the market. Buying in an area of demand or selling in an area of supply will always offer us the higher probability trades, and if we use the Stochastic as another level of confirmation there will be a far more likely chance of trade success. In essence, we should look to focus on price first, then the indicator and not the other way around.

With so many indicators available to traders via their charting packages, it is no wonder that the temptation to search for the Holy Grail prevails, but we all need to recognize that these tools should never be used as a crutch to lean on in times of uncertainty. Thorough planning, risk management and objective analysis is all any trader needs for consistent results. Price will always be the very best indication of all; and core strategy of supply and demand zones along with trend will give you a better chance to stay ahead of the pack.

Have a great week and take care,

Learn to Trade Now