I once loved trading off indicators. They were the holy grail to big profits. Let that stochastic hit overbought conditions while piercing the bollinger band and I was taking that short signal while already counting my profits. It didn’t matter that the stock was part of the hottest sector in the market, I went with what the holy grail indicators were telling me.
Needless to say I was in for a rude awakening and some big losses.
Indicators seduce beginning traders into thinking there is a magic formula that can predict what a stock will do with pin point accuracy. Indicators create the facade of precision and control. However, it is an illusion. A crutch traders blindly hold onto because they do not truly understand the relationship between momentum, volume and price action.
Buffet of Trading Indicators
When I started out trading my charts looked like a map of the Los Angeles freeway system. In other words, a jumbled mess. I literally had over 11 indicators on my charts.
No, I am not joking.
At my height of my own indicator-mania, my charts were cluttered with bollinger bands, two stochastics indicators, two RSI indicators, on balance volume, MACD, Chaikin Money Flow, Volume by Price and one proprietary indictor that I spent hundreds of hours developing.
Needless to say, these indicators left me more confused than ever and losses mounted. Like most beginning traders, I quickly learned indictors were not a magic formula to 100 percent win rates.
7 Reasons Not to Use Trading Indicators
- Information overload: Trading is a decision making game. Good decisions come from clear signals and simplicity. Indicators do not simplify. Rather, they increase the amount of data that a trader must process.
- Price action inaccuracy: Traders are beholden to price action. At the end of the day, it is the only thing that matters. You do not make money from indicator movement, but from price movement. Many times your indicator is not consistent with price action signals.
- Support and resistance levels: Most indicators either ignore support and resistance levels, or inaccurately factor them.
- Lack of higher level thinking: Striving for simplicity does not mean traders do not analyze price action at a deeper level. Indicators keep traders focused on surface level thinking.
- False entry signals: While indicators can be a decent guide, they do not give good entry signals. For instance, oversold stocks can become more oversold. Entering at oversold levels often is a losing proposition without higher level thinking.
- Mixed signals: The more indicators you add to your charts, the more mixed signals you will get. There is not worse experience in analyzing your data than having one indicator telling you to buy while the other tells you to sell. Analyzing price action and volume on it’s own gives one signal.
- Irrelevance: Once you take the focus off indicators and master price action, volume and trading setups, you will no longer need indicators. For instance, I still keep 1 stochastic indicator on my charts but rarely even look at it. Price action tells me when the stock is overbought or oversold, not the indicator.
How to Get Rid of Trading Indicators
Use this 7-step approach to decrease your reliance on indicators.
- Take all indicators off your charts
- Make a list of 1000 charts.
- Study each of these charts over a given time period
- For each chart, ask yourself where the stock is overbought and oversold according to price action.
- Next ask yourself what volume is telling you.
- Finally study optimal entry levels.
- Take notes for each chart and study the patterns
After completing this exercise, you will no longer need to use indicators and will have a deeper understanding of price action and the characteristics of the stocks you trade. Better results should follow.