Using indicators in trading. How to do it and why?

Using indicators in trading. How to do it and why?

Forex indicators are graphical analysis tools for visualizing currency market signals.

Hello everyone!

In this article, we will talk about such an ambiguous analysis tool as indicators. The Internet does not stop arguing about their usefulness in trading: someone thinks they are completely meaningless, and someone, on the contrary, has built an indicator strategy and tries to counter argue in their favor. Of course, opinions differ, so from the start I will make two small remarks:

• I myself use the horizontal levels in trading and nothing else - I'm happy with them and using something else is excessive for me. Nevertheless, I do not at all consider trading from levels to be the only true method that surpasses all others in efficiency.
• I sincerely believe that in trading, you need to find something that makes sense and works specifically for you, and there isn’t one correct analysis method. However, it is better to lose everything not usable for price analysis as soon as possible.

Of course, everything below is a subjective point of view of the author, which, nevertheless, has a very significant statistical and logical basis, and is also based on a fairly long trading experience.

It will not even be so much about the advantages and disadvantages of indicators, as about the lack of traders’ understanding of the fundamental factor, due to which these indicators are used, so to say, "not for their intended purpose".

I sincerely believe that in trading, you need to find something that makes sense and works specifically for you, and there isn’t one correct analysis method. However, it is better to lose everything not usable for price analysis as soon as possible.

I think the article will be of interest to those who view indicators as some magical tool for predicting price movements. Maybe it will prompt experienced traders to reconsider their trading approach and stop concentrating on unnecessary things. So, let us start.

Personal experience

The very first thing I did when I opened the terminal for the first time was that I put a bunch of absolutely DIFFERENT indicators on the poor EUR/USD. Well, it looked pretty awful too. I looked at it and did not understand what I wanted to achieve with this. However, even then I subconsciously wanted to find the very one indicator, which would be "mine", not the same as the rest, but much better. I wanted it to do what other indicators could not do - namely, show WHERE the price will go. I listened to stupid stories of traders that traded on some "probabilities", laughed to myself at their stop loss signals and believed that they were just too lazy to go beyond and stopped in their development. I, on the other hand, certainly will achieve the state when at every moment of time I know where the market will go. We all feel we are winners in life.

So, the next step of my career was to select such indicators and such parameters that I would be absolutely sure the indicator forecasts the price behavior. I was leaning towards the Bollinger Bands with the parameters 20:2 and the RSI with the parameters 8 and 12.

The Trading Guru stage

I added them to the chart and, like many people did before me, I saw a miracle: the price magically rebounded from the upper border of the BB and went to the lower one, and if at the time of the rebound the RSI was about 50%, I could enter right at the reversal. "Haha, losers," I thought. Stupid little traders. They trade on probabilities, they have stop loss. Here it is, the Holy Grail. Right before your eyes. The price approaches the upper border, the RSI is below 50 - go down. The price approaches the bottom, the RSI is above 50 - go up. Is there an easier way to earn on a yacht with $10?

And I started to trade. In the history, everything was divine - for the last year, trading on the timeframe H1, according to my calculations, the average monthly profit would have been about 400 points, and I was looking forward to being a trading guru. But as some of you probably guessed, in reality something went wrong. No, naturally there were profitable trades, and the trading was quite comfortable for me, because I understood where to enter, where to stop, where to take profit. I had a system, but I felt that something was going wrong. I saw that the market moves have changed - they have become broader, and with my "reversal strategy", I often found myself in a situation where I sell from the upper boundary of the BB, and the price is rising. Then it seems like a rollback down, I sell again, and the price grows again... "What the hell is happening," I thought. Apparently, I did something wrong: I picked up the wrong parameters of the indicators, or maybe the indicators themselves were bad. I was still far away from the emergence of the most important issue in the life of a trader.

The essence of indicators

Let us try to figure out what the indicators show us. We will take one trend indicator and one oscillator. Let's analyze the widely known moving average and the stochastic oscillator.

Moving averages

So, the moving average (let's take the simplest one) is just an average price for some period in the past. For example:

Tomatoes the day before yesterday - 37 rubles / kg
Tomatoes yesterday - 50 rubles / kg
Tomatoes today - 42 rubles / kg

Now calculate the moving average with a period of 2. This means that we are taking the average price for the last 2 (at the time of calculation) periods.

SMA (the day before yesterday and yesterday) = (37 + 50) / 2 = 43.5 r.

SMA (yesterday and today) = (50 + 42) / 2 = 46

Therefore, the price chart of tomatoes with a moving average will look like this:

What do we see? We see that the price of tomatoes crossed the SMA (2) indicator from the top down. Now those who know what the classic analysis tells us about the trend in this situation, raise your hand.

It tells us that the trend has changed, and now it is descending, and therefore we need to sell, because. the price will decrease.

"No, no," - others will say, "now is a great opportunity to buy. After all, the price fell slightly below the SMA, and hence the trend is still ascending and the price will continue to grow”.

My question to both groups: how you know? How do you know what the price will do in the next hour, the next minute, the next second? Did the intersection of the two lines on the chart tell you about this? If we move away from trading and return to tomatoes as a commodity - how exactly does the fact that today they cost 42 rubles, and yesterday - 50 rubles, tell us what will happen to the price tomorrow? Will it decrease / increase because now they cost 42 rubles, and their average price for yesterday + today = 46 rubles? Do you think that maybe something is wrong here?

How do you know what the price will do in the next hour, the next minute, the next second? Did the intersection of the two lines on the chart tell you about this?

Oscillators

Let us move to oscillators

The simplest and most popular oscillator is the stochastic. Simply put, for calculation, first it takes a certain number of periods (for example, 5), for which the maximum and minimum prices are determined.

• Maximum price = value 100 (overbought)
• Minimum price = value 0 (oversold)

And after that, the oscillator shows where the current price is in relation to the maximum and minimum value (attention!) IN THE PAST.

Let's look at the extended example with tomatoes:

Tomatoes Monday -37 rubles / kg.
Tomatoes Tuesday - 40 rubles / kg.
Tomatoes Wednesday - 37 rubles / kg.
Tomatoes Thursday - 50 rubles / kg.
Tomatoes on Friday - 42 rubles / kg.

Suppose our oscillator has a period of 3. We calculate where the oscillator will be for "the day before yesterday". For this, we only take these values:

Tomatoes Monday - 37 rubles.
Tomatoes Tuesday - 40 rubles (max value).
Tomatoes Wednesday - 37 rubles / kg (min value).
The oscillator will show approximately 33.
Let’s calculate further:

Tomatoes Tuesday - 40 rubles / kg
Tomatoes Wednesday - 37 rubles / kg
Tomatoes Thursday - 50 rubles / kg

The oscillator now sharply rises to 100, because last price (yesterday) is the maximum for 3 periods

And one more time:

Tomatoes Wednesday - 37 rubles / kg
Tomatoes Thursday - 50 rubles / kg
Tomatoes on Friday - 42 rubles / kg

Pay some attention here:
50 - max. price
37 - min. price

If now the price is 42, it roughly corresponds to the oscillator value of 38.

It seems that everything is not bad, right? There is an overbought zone and an oversold zone. Below - buy, above - sell.

Imagine that it is Saturday and the price of tomatoes dropped to 40 rubles / kg

What we have:
Tomatoes Thursday - 50 rubles / kg
Tomatoes on Friday - 42 rubles / kg
Tomatoes on Saturday: 40 rubles / kg (min value)

Therefore, the oscillator will show 0 - oversold zone, "very cheap", it's time to buy, isn’t it? "Yes!" - some will say. "No," others will say, "you have to wait until the oscillator goes up, and then you buy it."

Ok, let's imagine that on Sunday the tomatoes are again 40.5 rubles

Then:
Tomatoes on Friday - 42 rubles / kg
Tomatoes on Saturday - 40 rubles / kg (min value)
Tomatoes on Sunday - 40,5 rubles / kg.

The oscillator shows a value of 25. We’ve got a confirmation! Should we buy? Well, surely now is the time – we have a confirmation. But ask yourself this: what is this confirmation? What exactly does it confirm and how?

If we look only at the price, we get the following logical chain: if the price on Wednesday was 37 rubles, on Thursday - 50 rubles, on Friday - 42 rubles, on Saturday - 40 rubles, and on Sunday 40.5 rubles, then tomorrow price will grow. Do you understand the absurdity of the situation?

What do we do?

To sum up, I would like to tell you the following: before using anything in my trade, you need to understand the essence of it and the mechanism of its work. The indicators themselves are quite a good tool. They serve their direct purpose perfectly – they calculate certain coefficients from the price data. The moving average will show you how much the current price deviates from the average for a certain number of periods. The stochastic accurately shows you how the current price differs from the maximum and the minimum over the past few periods. Similarly, any indicator will show you the most accurate calculations of what it is intended for.

But if you are going to use indicators for predicting the further behavior of the price - you are doing anything but the analysis of the price chart.

Indicators are not intended to predict the price. They were created for comparing the current value of a price with its past values. Therefore, they do not have an element that would help you in predictions - you cannot predict what will be based on what already happened, otherwise there would not be wars, financial crises and other unpredictable calamities to which humanity is not ready every time.

Any indicator will show you the most accurate calculations of what it is intended for.

But if you are going to use indicators for predicting the further behavior of the price - you are doing anything but the analysis of the price chart.

I'm not saying that the price will never go where the indicators predict - of course, sometimes it will happen, because the price can go both up and down at any time, and market conditions are constantly changing. But the very approach to predict the price with the help of indicators implies that you are trying to predict the price using the price (specifically, using its past values, since indicators make calculations based on the past price data). Think about it, does it make any sense?

"What should I do then?" - the indignant reader will ask (at least, this is what I asked when I came to understand the unpredictability of the price).

You need to change your way of thinking, perception of the price schedule and your understanding of trading in general. Try to accept sincerely that if there was a trader who could predict the price movement, they would have already earned ALL MONEY IN THE WORLD, because they would always be right, and sooner or later there would not be anyone left who could trade with them.

Trading is not predicting the future. Trading is working within an understandable market situation with the awareness of the probable nature of the outcome of this situation + risk management. But alas, probably every trader needs to go through the mistake of creating a predictive trading system in order to realize it’s impossible.

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