Combining Technical Indicators

Once you have made the rounds and done your research to gain an understanding of some of the most commonly used technical indicators, it is important to start focusing on strategies that will allow you to maximize your gains and spot the highest probability opportunities present in the market.  One of the best ways of doing this is to use more than one technical indicator at a time.  Combining indicators can help spread betters to separate your trades and become more selective before actively pulling the trigger and putting real money on the line.

 

But which indicators should be combined?  Unfortunately, there is no direct answer here that will work for all trading styles.  But the important thing to remember is that the indicators you chose should come from different categories, as doubling up on similar indicators will not really give you any new information.  It will also not go far in helping your probabilities for success.  Here, we will look at the main types of indicators so that spread betters know which indicators are most compatible when defining a trading strategy.

Trend Indicators

 

Trend indicators are technical tools that help spread betters measure the strength and direction of a dominant price move.  To accomplish this, the indicator’s underlying formula will use price averaging to determine an historical baseline for where prices “should” be.  When prices are consistently moving above this area, an uptrend is in place.  A downtrend is present when prices are below this baseline.  Common trend indicators include:

 

  • MACD
  • Parabolic SAR
  • ADX
  • Simple and Exponential Moving Averages

 

There are many traders that will use trend analysis as a starting point in constructing a trading bias and then combine it with another indicator to confirm the reading.  Understanding the dominant trend is important because it shows you where the majority of the market is positioning.  It is then your choice to decide whether or not you want to side with the majority in an active trade. 

 

Momentum Indicators

 

Momentum indicators measure the rate at which prices are changing over time.  This indicators are immensely useful because changes in momentum are often seen as the precursor to new changes in trend. Common momentum indicators include:

 

  • RSI (Relative Strength Index)
  • CCI (Commodity Channel Index)
  • Stochastics

 

If you are able to get in early on a trend before it fully develops, there can be significant profits to be made using buy (or sell) and hold strategies.  Momentum indicators can be very helpful in identifying these situations.  It should be remembered that the momentum approach tends to work better on bigger time frames (ie. daily or weekly charts), as momentum changes on shorter term time frames tend to be more erratic and less predictable.

 

Volatility Indicators

 

Volatility indicators are useful in determining the likely price range of a given asset.  For some, the word “volatility” has a negative connotation but the word simply means that prices are changing at a greater rate than was seen previously.

 

Common volatility indicators include:

 

  • ATR (Average True Range)
  • Standard Deviation
  • Bollinger Bands

 

Those familiar with these indicators know that they generally define outer parameters for where prices are likely to travel.  When volatility is increasing, trading ranges increase.  If volatility is in decline, spread betters will start to expect smaller trading ranges.  This can be very useful when defining your trading parameters (trade entry, stop loss, and profit target). 

 

These volatility tools can also be useful in signalling when a smaller trading range is breaking, and this could be another indication of an emerging trend.  More conservative traders tend to stay away from volatile markets, but those with a more aggressive outlook see these situations as supreme opportunities -- after all, no money can be made if markets are standing still. 

 

Volume Indicators

 

Volume indicators are used to measure the amount of trading activity in an asset over a given time period.  Spread betters watch these indicators to identify situations where the majority of the market is starting to take action in a given asset.  When volumes are surging, opportunities become present and the moves associated become more valid because a greater share of the market is taking an active stance.

 

Common volume indicators include:

 

  • ROC (Rate of Change)
  • Chaikin Oscillator
  • On Balance Volume

 

In practice, trends are viewed as more sustainable when volumes are rising.  So for example, if we saw a positive trend indicators in conjunction with rising volumes it would be a good idea to consider long positions as it is more likely an uptrend is ready to occur.  In short, volume indicators tell you how much of the market is actively trading in any given time.

 

Conclusion

 

Most traders would argue that using any one indicator alone is not the best approach.  When we combine indicators from different categories, we are able to validate the signals we are receiving and focus solely on the trades that look strong from multiple viewpoints.  Above, we looked at four different indicator categories technical traders that can use to define their approach.  It is recommended to use no more than two or three at a time, however, as the use of too many indicators can be just as disruptive as using too few.