What are technical indicators?
In technical analysis, indicators are purely mathematical calculations based on the historical data of a financial instrument – primarily the price (open, high, low, close) and more rarely the trading volume. While bare price action is often chaotic and characterized by market noise, indicators smooth out this data. They visualize complex relationships in simple lines or histograms.
The primary goal of an indicator is to objectify the trader's decision-making process. They take the emotional component out of the analysis and provide quantifiable, hard data about the current condition of the market.
The two main types of indicators
Fundamentally, the countless available indicators can be divided into two broad categories, each fulfilling a specific purpose:
- Trend-following indicators (Lagging Indicators): These tools, such as moving averages or the MACD, confirm an already existing trend. They "lag" behind the current price, but in return filter out the noise. They are particularly useful in markets that show a clear direction, but often fail in sideways phases, as they provide false signals there.
- Oscillators (Leading Indicators): Indicators like the RSI or stochastics swing (oscillate) between fixed values, usually 0 and 100. They are intended to indicate when a market is "overbought" or "oversold", and can form divergences with the price, which point to an impending trend reversal. They are particularly strong in ranging markets (sideways markets), but can remain in the extreme zones for a long time in strong trends and provide early false signals.
Dedicated pages explain the most important indicators: moving averages, Golden and Death Cross, RSI, MACD, stochastics and Bollinger Bands.
Indicators in the four trading styles
Depending on the chosen trading style, the way and on which time frame indicators are used changes fundamentally.
Indicators in scalping
In scalping (15m, 30m), speed is everything. Here, fast oscillators with short period settings are used to capture micro-movements. Since the noise is extremely high, indicators here mostly serve only as a secondary filter alongside the order book or volume, in order not to open a trade against the extremely short-term momentum.
Indicators in day trading
In day trading (1h, 2h), indicators play a central role in structuring the trading day. A popular approach is the use of moving averages (e.g. EMA 20 and EMA 50) to determine the short-term trend direction. Day traders often combine this with oscillators to find corrections within this trend and to enter pro-cyclically at the end of the correction.
Indicators in swing trading
Swing trading (4h, 8h) is the classic terrain for combining oscillators and trend-following indicators. An RSI divergence on the 4-hour chart, confirmed by the crossing of two long-term moving averages, is a classic and robust setup for a trade that is held for several days. The signals are rarer, but significantly more stable due to the filtered noise.
Indicators in position trading
In position trading (12h, 1d), the focus shifts extremely towards macroeconomic factors. Indicators are primarily used here to technically confirm the fundamental trend. A crossing of the 50-day line with the 200-day line (Golden Cross) on the daily chart has a great signaling effect for many institutional investors, but mostly only serves for the final fine-tuning of the entry. In the FinScans signals, “Golden Cross” stands for the crossing of the 20-period moving average above the 50-period moving average.
Hybrid trading with indicators
The biggest mistake traders make with indicators is the search for the "Holy Grail". No indicator works 100 percent in every market phase. FinScans looks for indicator triggers on the forex and crypto pairs and lists them on the signal page; it does not show a class for indicators. However, the human trader must examine this signal in context. An oscillator signal for a long entry is significantly more valuable if it occurs exactly at a historical support zone. The hybrid workflow requires that the machine indicator calculation is supplemented by the human context analysis of the chart structure and the fundamentals.
Frequently asked questions
Which indicator is the best?
There is no perfect indicator. Oscillators are strong in sideways markets, trend followers in trending markets. The art of trading consists of recognizing the condition of the market and choosing the right tool for this condition.
Why do indicators produce false signals so often?
Indicators can only calculate the past. They are blind to the future and especially blind to news. A suddenly published inflation figure or a tweet from a central banker will invalidate any mathematically calculated indicator value within fractions of a second.
How many indicators should I use on my chart?
As few as possible, but as many as necessary. The use of five different oscillators brings no advantage, as they all provide similar information (multicollinearity) and only make the chart cluttered. A clean chart with one or two well-understood indicators is mostly clearer in practice.
Sources
- John J. Murphy: Technical Analysis of the Financial Markets. New York Institute of Finance.
- Alexander Elder: Trading for a Living. Wiley.
- Perry J. Kaufman: Trading Systems and Methods. Wiley.