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Using Technical Indicators To Develop Trading Strategies

Technical indicators like moving averages and Bollinger Bands are used to analyze past price trends and anticipate future movements. Traders use indicators to help develop trading strategies with rules for entry, exit, and trade management. Strategies specify exact conditions for establishing trades and adjusting or closing positions, often combining multiple indicators. While strategies vary, indicators are commonly applied objectively within strategies to determine trading activity.

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159 views2 pages

Using Technical Indicators To Develop Trading Strategies

Technical indicators like moving averages and Bollinger Bands are used to analyze past price trends and anticipate future movements. Traders use indicators to help develop trading strategies with rules for entry, exit, and trade management. Strategies specify exact conditions for establishing trades and adjusting or closing positions, often combining multiple indicators. While strategies vary, indicators are commonly applied objectively within strategies to determine trading activity.

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astro secretes
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© © All Rights Reserved
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Using Technical Indicators to Develop Trading Strategies

Indicators, such as moving averages and Bollinger Bands®, are mathematically-based technical
analysis tools that traders and investors use to analyze the past and anticipate future price trends
and patterns. Where fundamentalists may track economic data, annual reports, or various other
measures of corporate profitability, technical traders rely on charts and indicators to help interpret
price moves.

The goal when using indicators is to identify trading opportunities. For example, a moving average
crossover often signals an upcoming trend change. In this instance, applying the moving average
indicator to a price chart allows traders to identify areas where the trend may run out of gas and
change direction, which creates a trading opportunity.

KEY TAKEAWAYS

Technical indicators are used to see past trends and anticipate future moves.

Moving averages, relative strength index, and stochastic oscillators are examples of technical
indicators.

Trading strategies, including entry, exit, and trade management rules, often use one or more
indicators to guide day-to-day decisions.

There is no evidence to suggest that one indicator is foolproof or a holy grail for traders.

Strategies (and indicators used within those strategies) will vary depending on the investor's risk
tolerance, experience, and objectives.

Strategies frequently use technical indicators in an objective manner to determine entry, exit,
and/or trade management rules. A strategy specifies the exact conditions under which traders are
established—called setups—as well as when positions are adjusted and closed. Strategies typically
include the detailed use of indicators (often multiple indicators) to establish instances where trading
activity will occur.

While this article does not focus on any specific trading strategy, it serves as an explanation of how
indicators and strategies are different (and how they work together) to help technical analysts
identify high-probability trading setups.

Indicators

A growing number of technical indicators are available for traders to study, including those in the
public domain, such as a moving average or the stochastic oscillator, as well as commercially
available proprietary indicators. In addition, many traders develop their own unique indicators,
sometimes with the assistance of a qualified programmer. Most indicators have user-defined
variables that allow traders to adapt key inputs such as the "look-back period" (how much historical
data will be used to form the calculations) to suit their needs.

A moving average, for example, is simply an average of a security's price over a particular period.
The time period is specified in the type of moving average, such as a 50-day or 200-day moving
average. The indicator averages the prior 50 or 200 days of price activity, usually using the security's
closing price in its calculation (though other price points, such as the open, high, or low, can also be
used). The user defines the length of the moving average as well as the price point that will be used
in the calculation.

Strategies

A strategy is a set of objective, absolute rules defining when a trader will take action. Strategies
typically include trade filters and triggers, both of which are often based on indicators. Trade filters
identify the setup conditions; trade triggers identify exactly when a particular action should be
taken. A trade filter, for example, might be a price that has closed above its 200-day moving average.
This sets the stage for the trade trigger, which is the actual condition that prompts the trader to act.
A trade trigger might occur when the price reaches one tick above the bar that breached the 200-
day moving average.

A strategy that is too basic—like buying when price moves above the moving average—is usually not
viable because a simple rule can be too evasive and does not provide any definitive details for taking
action. Here are examples of some questions that need to be answered to create an objective
strategy:

What type of moving average will be used, including length and price point used in the calculation?

How far above the moving average does price need to move?

Should the trade be entered as soon as price moves a specified distance above the moving average,
at the close of the bar, or at the open of the next bar?

What type of order will be used to place the trade? Limit or market?

How many contracts or shares will be traded?

What are the money management rules?

What are the exit rules?

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