Stupid technical indicators
Every week I get a ton of emails asking me about the “perfect” technical indicator, what parameters should I use with this indicator, etc, etc, etc.
And I always answer the same thing: “Look my friend, I dont use technical indicators and dont recommend you to use them, at least not as a trigger signal”.
Heck, I’m thinking about using a generic email template to answer this question…
Anyway… I was thinking about a way to help you get rid of technical indicators (for the reasons I explain below)… And came up with something.
So here is the deal:
Every night, before you go to bed, you need to repeat “Stupid technical indicators” five times…
Maybe by the third night, you’ll start believing it. By the fifth night, you’ll start looking for other ways to profit from the market… :D
Or maybe you can propose another solution to your fellow traders to stop relying on technical indicators?
Share your thought in the comment section. In the meantime let me show you my case against technical indicators.
How technical indicators really work
Technical indicators, such as moving averages, stochastics, RSI, CCI and others use historical values of price to determine it’s final reading or value. In other words it’s just a different way to explain what the market is doing.
Each indicator applies a formula to historical price values to calculate the final reading of the indicator.
So if you are using a Moving Average of 21 periods MA(21), it will use the last 21 bars or candlesticks to calculate the final reading of the indicator.
The final reading you see on the right hand side of your chart, is the result of the formula applied to the technical indicator (in this case a moving average), using the last 21 one periods or candlesticks.
Now, moving averages are simple indicators, there are other indicators a little more complicated than MA’s. For instance, stochastics, which oscillate between 0 and 100 or MACD which is a combination of two MA’s with a histogram.
But at the end, they all use the last “n periods” to calculate its final reading.
If you are using RSI(21), its the same thing. It will apply a mathematical formula to price, using the last 21 periods or candlesticks. And the same goes for CCI, MACD, stochastics, etc.
Ok, now you know how they work… now the fun part.
My case against technical indicators
It is very important to understand why I don’t recommend using technical indicators as a trigger signal. Its alright to use them as a confirmation or filter, but never as a trigger signal, and here is why.
If you happen to use technical indicators, don’t take it personal, this is just my personal view of the market alright?
Sometimes I ask myself about why there are so many indicators?
It just seems as if there is a technical indicator to describes every market movement.
And then it just clicked, I realized that that’s exactly the reason there are so many indicators: traders always want to have a reason or explanation of every type of movement.
We can’t help it, as humans, we are wired that way, we always want an explanation of everything, and once we find it, we feel fulfilled and makes us think (only think) we are in control.
The thing is, sometimes the market behaves in unexpected ways, that’s just how the market works, this happens in the forex market, stock and futures market and all other markets.
What we need to learn is this: it’s ok not to understand every market movement of every currency pair. We just need to focus in the type of movements that currency pair that have a higher chance of moving in one direction over the other.
Once you believe in that statement, you’ll begin to see the market in a different way, you’ll begin to see opportunities that always were there, but you were unable to see them because of what you thought about the market.
Try it, you’ll not regret it.
Forget about trying to figure out what the market is doing every minute, in order to profit from the market we dont need this, we just need to focus in the moments when the market is predictable, when it’s clear what the market is likely to do.
Imagine what kind of results you’d get if you only traded when there is a higher chance of the market moving on one direction over the other…
Are you still thinking about using technical indicators as a trigger signal?
Lets go back to MA(21) example.
What happened in the last 21 one periods, has absolutely nothing to do with what the market is likely to do next…
Yeah sure, if the market on average has been moving up in the last 21 one periods, it is likely to continue its way up, right?
Yep, you could say that, but… (there is always one but).
What if the market is approaching to an important resistance level?
Would you buy?
Here is the difference between an indicator and price action:
What the indicator is telling me is that on average the market is going up, but what price action is telling me is that when the market approached to that level before, it got rejected.
What would you do?
I’ll definitely go with the latter.
They say the best way to predict the future is by studying the past.
Look, this is the way I see it:
I don’t know why the market was rejected from that resistance level, but I don’t need to know the “why”, the only thing I need to know is that at that level, sellers are likely to jump in again, buyers are likely to start closing their longs, and at the end, the market is likely to fall back down.
All these will make me think twice about opening a long trade, even when technical indicators signal a long trade.
The same goes for other technical indicators such as RSI, stochastics, CCI and all other indicators work in the same way. They use the last n amount of periods, and they tell you how the market behaved in those n periods, which has nothing to do with how the market will behave in the future.
Are you saying technical indicators are useless?
As a trigger signal yes, they are completely useless, but not as a confirmation or to filter out the bad signals from the good ones.
- So you could use a MA, to determine whether you are going to look for long or short opportunities (setup)
- Or an stochastic to confirm your price action entry
- Or RSI reading above 50 to determine a bullish condition, and gives you a green flag to start looking for long opportunities.
- And so on and so forth.
You see the difference between using them as a signal:
Once the RSI reading goes above 50 I will go long
And using them as a confirmation:
Once the RSI moves above 50 I’ll start to look for long opportunities
The first one (as a trigger signal) will not work, while the second one will give you a better chance of success.
Are you with me?
What about Fibonacci or Elliot Waves or Gann?
Alan Greenspan, in my opinion the best forecaster ever. In his book “The Age of Turbulence” mentions what he thinks about currency forecasts:
“…forecasting exchange rates for major currencies is as accurate as forecasting the outcome of the flip of a coin.”
If this is what the best forecaster in the world thinks about forecasting currency movements, what’s left for us?
Let me tell you what I think.
Well, I don’t think we (traders) should be moving in that direction about “forecasting movements”
It’s all about adapting.
And by “adapting” I mean, instead of trying to guess (some traders name it “forecast”) what the market is going to do… We should trade based on what the market is actually doing.
In other words, let the market make its first move, let the market tell you where it is heading, and once you are confident about the direction the market is likely to take, then make your move.
See the difference?
Instead of trying to guess, you patiently wait for the market to tell you which way it is heading.
Elliot Waves, Fibonacci and Gann are probably the result, again, of trying to find an explanation of every single movement of the market.
Are you with me?
Put it in terms of your real goal
Let’s put it this way…
I know trading is just the medium for something else.
You are trading because you want to quit your regular job, you want to spend more time with your family, you want to earn more, you name it… write down whatever is your final goal…
Now, think about this: Would you risk your ___________________ (final goal goes here) on actual data (like price action – what the market is actually telling you) or on something subjective (like Technical indicators or Elliot Waves or Fibonacci – what you think the market will do)?
Spend some time thinking about this, then think about it some more.
Remember we are talking about your final goal, what you really want to accomplish, so you need to be serious about this.
One note: if you use technical indicators and are successful using them, keep using them, dont try to fix what its not broken.
What do you think about technical indicators?
I’ll appreciate if you share your thoughts in the comment section.