Thursday, 3 December 2015

Why having too many Indicators is BAD

Are You High on Technical Indicators? Come Down!

Some people go camping and bring with them half of the apartment: fork for the steak, fork for the salad, coffee cup, tea cup, pillows, pliable table and chairs, three tons of food, socks for a week even if they are planning on staying just two days… and women bring makeup of course. God forbid the bears, birds and insects will see them without makeup on. What’s that have to do with trading? Well, similarities are all around us and there is one here as well – too many indicators.

Bad Trades? Add or Delete Indicators?

The type of camper I talked above has a “twin brother” trader. Just how that camper wants to make extra sure he has all the comfort of the city, some traders want to make extra sure they can filter out all bad trades and they do this by adding indicators on their charts. Now don’t get me wrong, having more than one confirmation for your trade is not a bad thing, but at a certain point it becomes too much and the effect will not be the desired one. Usually this guy who hoards indicators on his charts will find a strategy on a forum somewhere – 2 or 3 indicators, maybe some price action and multiple time frame analysis – and although it works fine as it was presented by the developer, he will try to “fix it”. Oh, look, I found a losing trade. Let’s add some extra filters for bad trades. That’s when it all begins and a simple, easy to trade strategy gets turned into a hairy monster with 100 rules and indicators. Look at this:

Too Many Indicators Preview

I cannot trade something like that. Maybe there are people who can but first of all, I cannot see the price very well and second, I am sure all those indicators will give me contradictory signals. One will indicate a Put while other will say I should place a Call and by the time all of them agree price is long gone and the move is exhausted. Or even worse, maybe I get frustrated by all the waiting and I will fire off the trade before all the rules are met.

Then there’s the multiple time frame issue: probably many of you have heard about Multiple Time Frame technique which involves analyzing the charts on more than one time frame. For example, you trade the 15 minute chart but you also look for the trend on an hourly or four-hour chart and only take trades in the direction of the trend identified on the higher time frames. Ok, that’s a sound “tactic”, but it doesn’t come without its traps. First of all, just like in the case of indicators, if you start using too many time frames you will get mixed signals: one time frame will say UP while 2 or 3 others will say DOWN. Second, there’s an important correlation between time frames which must be taken into account: say you trade the 5 minute chart and you want to go only in the direction of the higher time frame chart. Well, if the higher time frame of choice is Monthly… it doesn’t really help. A 5 minute chart and a Monthly chart have almost nothing in common because you can see a downtrend on the Monthly chart but on a 5 minute chart, a good uptrend can be in place. Maybe at a certain point the uptrend on the lower time frame will turn into a downtrend, agreeing with the Monthly trend, but the time it takes to do that will most likely exceed the expiry of your binary option trade. The point is that you must use time frames which are not too far apart and not too close and don’t exaggerate, don’t use 5 or 6 timeframes because you‘ll just become confused.


Bottom Line is: You Should KISS – Keep It Simple, Silly!

Don’t get spun on too much data, too many indicators and too many time frames. Sometimes when it comes to this kind of stuff, less is more. I’m not saying you should make all your trading decisions based solely on one indicator and one time frame, but you must find a balance. Always stick to what you understand because ultimately it comes down to what fits your personality: maybe a trader is only comfortable if he has 10 indicators on his chart but that doesn’t mean that everybody should trade that way. Especially if you are new to trading, you should heed the words of Albert Einstein: “Make everything as simple as possible, but not simpler.”