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How to Use Trading Indicators Effectively

How to Use Trading Indicators Effectively

By Rainbow Runner - 08-Sep-2023

Almost every successful trader uses some form of technical analysis as their compass in the vast ocean of the markets. Every trader also has a cherished set of signal tools and indicators that they’ve become comfortable with over time. But the hours traders put into thoroughly understanding their indicators and fine tuning their methods for identifying signals is often overlooked. 

New traders believe indicators and signals generate universally applicable trades for any asset, any timeframe and any trader. Charts brimming with indicators of all varieties may look intense and complex, but how should a trader discern reliable signals from noise? 

That’s the real art of trading with indicators. And it’s a challenge that’s frequently underestimated.

The Basics of Trading Indicators

Every novice trader begins their journey with some version of the same misconception: trading is a breeze. The truth is trading is hard, and the odds are stacked against traders, especially new ones. Even the most experienced traders bear the battle scars from lessons they learned the hard way.

In short, that's the point of this article.

Indicators can be very useful for interpreting market movements and choosing winning trade setups, but every trader needs to evaluate if an indicator fits their personal style and mindset. Taking cues from the painful lessons already learned by other traders can also be helpful before stepping into the fire that is the market.

Every trader has the same simple goal: don’t become liquidity for the market-controlling whales! And new traders must understand their tools inside and out before risking their hard-earned capital by taking positions in the market.

A proper understanding of indicators can help accomplish that.

Four Buckets for Trading Indicators

Before looking at any indicators, traders should understand there are four key categories that basically encapsulate all signals tools. 

  • Leading Indicators
  • Real-Time Indicators
  • Lagging Indicators
  • Ponzi Indicators

Here’s a short breakdown of all of these categories. 

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Leading Indicators

Leading indicators are tools supposed to be designed to predict the future.

In short, this group of indicators are intended to be early signals before price movement happens. But as with anything that attempts to predict the future, the fundamental limitation is accuracy. Due to their reliance on historical data, susceptibility to false signals, and the human factor, leading indicators are (obviously) not always accurate.

Market dynamics are constantly changing, and leading indicators might not account for unforeseen variables, which leads to inaccuracies. New traders should exercise caution when utilizing these types of tools. Maintaining a healthy skepticism about future signals to navigate financial markets is often overlooked.

These types of indicators usually work best on higher time frames, and they will struggle on lower time frames. A few tried-and-true leading indicators are:

  • Ichimoku Clouds
  • Fibonacci Retracements
  • Automated Pivots and Order Blocks

Lagging Indicators

Lagging indicators are often a trap for new traders.

While they can be enticingly accurate, their signals often arrive too late for real-time trading. Late signals, even if they are high accuracy, can cause many new traders to fall into the pit of overconfidence before they understand this crucial limitation. So, the proper approach to these tools is caution. Learn their ins and outs and navigate safely.

The biggest pitfall to this type of indicator is that they back test amazingly well. A new trader will believe they have a perfectly tested system ready to go to only see if it falls flat on its face during live trading.

It is crucial to do some live trading with any new strategy with a small chunk of capital that involves these indicators to ensure problematic issues are not discovered only after taking larger trades. Here are some lagging indicators to check out: 

  • Average True Range
  • Moving Averages
  • Exponential Moving Averages

Real Time Indicators

Real-time indicators walk the line between leading and lagging indicators.

These tools draw from live market data to offer up-to-the-minute insights. Even though they may not be as quick in generating signals as leading indicators, they often hit the mark with more accuracy. This type of indicator also gives traders a clearer picture of current market conditions, which can help make decisions in the blink of an eye.

Trading in the moment can be challenging initially. But new traders will quickly see the benefits gained from the accuracy of these signals. Some tried and true real-time indicators are:

  • On Balance Volume
  • Order Heatmaps
  • Liquidation Heatmaps
  • Option Order Flows
  • Relative Strength Index

Ponzi Indicators

Some programmers can be crafty when selling indicators.

Developers will sometimes dress up their signal products with bells and whistles that promise sky-high win rates. But it’s all smoke and mirrors. When a trader tests their tools in live trading, the truth comes out. Stay skeptical.

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This category of indicators manipulates historical data and edit out losing signals to present a picture-perfect view of their effectiveness. If any indicator really offered a 100% win rate, that money printing tool would never be sold to anyone. Traders looking for indicators should protect themselves from falling into these traps. 

“Can I Make It?”

Trading is a journey with ups and downs and unfavorable odds. 

In this competitive arena, every bit of edge is a blessing, but traders should remember to stay grounded. It's crucial for traders to find the indicators that genuinely resonate with their unique trading style and mindset. Everyone has a unique perspective on the market. Using the right tools that are tailored to personal needs will make a world of difference. 

Throughout my trading career, I’ve built a suite of custom trading indicators and bots. They fit some trading styles very well and others not as well. Learn more about the tools and bots I’ve built here. 

But with any indicators, traders should take their time to figure out what works and most importantly to find the tools that feel right in their hands.