This question came in the other day from a developing trader on the subject of technical indicators.
Dear Mr. Forman,
I’m a subscriber to your trading e-newsletter. I have a market question that I’d like to ask you. I often see it written on different market websites where they say that traders should use some kind of Technical Indicators on their charts to help determine the strength on a trend. I’m strickly a retail day trader (amateur lol), and mostly on using a 50 day moving avg on my charts and drawing my SR lines. I’ve tried lagging indicators like the RSI and MACD but they only seem to confuse me. I’m wondering which Indicators you think would be the most helpful to use for the shorter time frames that day traders trade in. Thank you so much and I look forward to your answer.
The first thing I’d point out is that all indicators are lagging in some fashion. Germain mentions RSI and MACD, but anything that uses historical data – and that’s all of them – has a built in lag effect to it. The further the look-back period, the greater the lag.
Now, certain indicators are meant to filter out the noise. Moving averages are in that category. They are meant to smooth out the ups and downs to indicate overall market direction. Longer moving averages will smooth out more volatility, but will be less responsive to market change, while the opposite will be the case with shorter averages.
RSI and other oscillator type of indicators basically tell you where the market is in reference to where it’s been. The idea there is that if it moves too far in one direction it will be overbought or oversold. The problem is that doesn’t work so well in a trending market.
To my mind, the best indicator of trend is the chart. Which way is it sloping? Stepping up a time interval from the one you’re trading to a higher one to look at the bigger trend can be very helpful. Again, you’re looking at history, so you there’s always a lag effect in your analysis (a trend will change before that change can be seen on the charts), but that’s just what we have to deal with.
No matter what I say, though, indicators (or the lack thereof) are an individual choice. We all have to pick things to look at that give us the specific information we require – and preferably no more than that. Decide how you want to trade and pick the things which help you identify trading opportunities or analyze the markets based on that approach.