Knowledge Base

How To Trade Using Indicators – Pitfalls To Watch Out For!

in Trading Indicators
Tags: pitfallstrading indicators

The NSE BSE and MCX are the leading stock exchanges in India and many traders old and new use indicator based trading to help form trading decisions daily. It helps garner and edge and identify a high probability trade entry and exit points. But what are the pitfalls new traders should look out for before getting their feet wet in the delightful world of indicators. Well, trading price action for so many years changes perspective, but one thing is for sure – there are no escaping indicators on your chart, they will seep into your trading even if you fight it! Price action traders use indicators sparingly, but like Bruce Lee said “Absorb what is useful, Discard what is not, Add what is uniquely your own.” bruce lee

Don’t miss the point – Price action always wins

Trading indicators are to be used to enhance your experience and not hinder them. Please remember that ALL indicators precede price action. Your first information is also the best and un-filtered, you have to use price action WITH indicators. Indicators by themselves only ‘indicate’ or give a hint towards possible oversold/overbought zones or upcoming tiredness of momentum. Look at this chart below of ACC, the company is one of the leading manufacturers of cement in India. Notice the red bar where we have drawn a black line, the MACD (Assuming your sell a crossover) is signalling a sell. On the other hand the price action is in an uptrend (moving higher fiercely) and we are within a consolidation pattern; they are also know as continuation patterns. They are temporary pause within a trend that allow the absorption of supply and usually will break upwards. ACC crossover1 Now the question is, will we sell because the MACD said so? You should NOT, price action always comes first. In this case, the markets broke out. Remember: Price action comes first, indicators should compliment your trading not confuse you

Indicator Redundancy – Multicollinearity is your enemy

Traders use the same data over and over again thereby using redundant information, multicollinearity means counting the same information twice or more. As we talked about before we have indicators that measure momentum and indicators that measure trend direction. New traders usually use the same type of information twice or more which brings down their probability of success.

The idea is to KISS – Analysis Paralysis

Keep It Simple Silly is a popular term professional traders use to describe the state of mind new traders are pushed into. They overcomplicate their charts/investment-strategies with many indicators that contradict and instead of improving our trading they damage our account and psychological state of mind to no end. Fear rises to the top of our head and we hit ‘Analysis Paralysis’. This is a state of mind where the trader can only go as far as analysisng, the fear developed over a few bad trades prevents him from taking any trades. Don’t get into this state, keep this simple. A chart below shows the use of an overcomplicated chart that will only result in information overload, focus on PRICE and the rest will follow! too many indicators is bad KISS

Magic indicator – Ultimate

The knights templar may have been hiding the holy grail but traders get into an amazing almost possessed search for a good indicator, then they search for the ‘best’ indicator, finally they enter the realm of no return by trying to find the ‘ultimate magic best in the world’ indicator. If you are in stage three of this disease let me save you some time and tell you that there is no such thing. The ingredients to a successful trader have less to do with indicators or methodology and more to do with discipline(following your trading plan).

Risk – Managed?

Finally, is your risk managed? Do you have a well laid out risk management plan? Make sure you do not lose more than a small portion on every trade you make; there are traders who lose their entire capital on 1 or 2 trades. DO NOT make this mistake, if you capital is 10 lakhs, make sure you do not lose more than Rs 5,000 or 10,000 per trade. We can all be wrong, if you keep trade sizes small you will live to see another day and still have a chance to ride winners big. If you found the article helpful, please use the buttons below to show some love