Every professional knows that the right tools are essential to success. A carpenter wouldn’t use a sledge hammer to nail an interior window frame, nor would he use a framing waffle head hammer. He knows that the ideal hammer for fine finish work is a finishing hammer that has a smooth head and is light weight. By using the right hammer for the job, the carpenter gets the results he wants.

 

The same applies to trading. Whenever a trader struggles with poor or mediocre results, one of the first things to check is their toolkit of indicators. Many factors can cause a trader to have disappointing results. Often, the primary culprit is a lack of the proper use and understanding of indicators. The most common problem is that traders will use several indicators that are basically all tracking the same market data and are missing indicators that are critical for tracking the full range of data for the stock. In essence, the toolkit of indicators is out of balance. That trader is using a sledge hammer instead of a finish hammer.

 

You need to track all of the aspects of market data available to you. This includes market condition, the trend pattern and the strength of that trend, the velocity of price action, large lot buying or selling patterns, price strength against its own recent price action, the quality of that price action, status of money flowing into or out of the market or stock, and the quantity of shares being traded.

 

Sadly, what most traders have in their toolkit of indicators is only one or two of these aspects of market data. Fortunately, this is one of the easiest trading mistakes to correct.

 

Indicators are just what the name implies. Indicators are the primary tool a technical analyst uses to determine an indication of market or price direction, velocity, and potential strength of such action. Indicators are not hard rules or precise facts but do imply what price is likely to do.  Investors and traders must use an indicator for what it was designed to do such as indicate over-bought or over-sold conditions, or accumulation or distribution. It is also important to remember that certain indicators do not work well under certain market conditions and that specific indicators were designed for short term evaluation rather than long term. And most critically, indicator settings need to be adjusted for market conditions, trading styles and trading strategies. As the market shifts and changes, you will need to modify your indicator settings and the types of indicators you use.

 

Market conditions, not strategies, define what indicators are best for that particular market. Do not make the mistake of trying to use a strategy and its indicators in the wrong market conditions. Many traders get so caught up with the latest “hot new strategy” that they forget the basics of first analyzing the current market condition and then applying the appropriate tools and strategies.

 

Market condition is an indicator unto itself. This defines how you should trade the market at that particular time. Market conditions are:

 

Trending up or trending down.

 

Wide sideways trading range.

 

Consolidating in a tight horizontal price action.

 

Insipid, also known as the dull market.

 

Momentum markets, the favorite market condition for day trading and swing trading.

 

A balanced toolkit of indicators is critical to your technical analysis skills and will shape your trading success rate. The ideal number of indicators is 5-7 depending upon the market conditions and your trading style.

 

For example:

 

Your toolkit of indicators should contain at least one or two quality indicators that you use in all market conditions. You should also set up your charts with 2-3 oscillators for sideways trending markets. Avoid using oscillators during momentum markets. Instead use velocity, quality, and trend indicators.

 

These are just some highlights of what you should know about indicators and how to properly use them. You can click on the links below to learn more about different types of indicators, how they should be used, and in which market conditions they work properly.

 

Velocity indicators, also known as momentum indicators, should be used to detect strength of price action as well as momentum moves.

Trend indicators should be used during trending market phases and not during sideways markets.

Accumulation and distribution indicators, also known as large lot indicators, are a must for all market conditions.

Quality indicators should be used in all market conditions and are critical for thorough evaluation of market data and stock price action.

Oscillators are designed to work in sideways trading range markets. They do not perform well in trending markets.

 

Do not use too many indicators as this will only confuse and complicate what should be a simple and easy to use toolkit. Instead, focus on the proper proportions of different types of indicators for your trading goals and style. And remember, that market condition is the first indicator you need to evaluate before choosing your indicators and strategy.

 

You need to know what kind of market you are trading before you can select the appropriate tools to use as indicators. There are several categories of indicators and each is used for a specific purpose and in a specific market condition. Our Senior Technical Analyst has written a publication, "How to setup your Indicator ToolKit." To purchase a copy of this publication or for more education on indicators and their use in today’s market, contact a Curriculum Advisor. You can also receive additional education about indicators on our free training DVD.