Reblog: Why I Ditched Technical Indicators (And Why You Should Too)
While the article talks about Forex, the underlying concept applies to stocks as well.
Technical indicators are no doubt a favorite topic in the financial markets. They can range from a simple moving average to a complex array of algorithms.
It doesn’t matter whether you’re trading stocks, commodities, futures or any other market; technical indicators are a common theme.
Useful? Well, that’s another matter entirely.
But of all the financial markets, Forex is arguably the worst offender of overutilizing indicators. Proprietary languages like MetaTrader’s MQL have made it relatively easy for newcomers to design anything imaginable.
Other trading platforms offer similar languages. There are even businesses that do nothing but custom code indicators for clients.
And if you ask me, it’s closer to being part of the problem than the solution.
With an infinite number of indicator combinations, how on earth are you supposed to find something that works?
Well, if your journey turns out to be anything like mine, you will dismiss the idea of using indicators as buy and sell signals. You may keep one or two as I did, but for the most part, they’re an unnecessary burden.
Everything you need to trade successfully is already on the chart; it has been the whole time.
In this post, we’re going to take a detailed look at why I decided to scrap technical indicators. I’ll also share what I use in their place.
As always, be sure to leave any questions or comments at the bottom of this post.
1. Indicators Distract From What’s Important
As a currency trader, what do you buy and sell?
Currencies, of course! That may seem like a silly question to ask a group of Forex traders.
But here’s the thing…
I wasn’t really buying and selling currencies when I was using indicators many years ago. I mean sure, I was technically buying one currency and selling the other.
But every decision I made was based on a signal from a group of indicators.
The chart underneath it all was inconsequential to me. It could have been the EURUSD, GBPUSD, AUDUSD or any other currency pair.
That doesn’t sound like a trader to me, at least not one who’s going to make money in the long run.
Of course, the underlying chart didn’t matter to me at the time because I was relying on a random set of lagging indicators to make decisions for me.
I thought I was being a trader.
The truth is I was being lazy. I was also following the herd blindly, hoping that I’d stumble across some magical combination of indicators that would make me wealthy.
But I can’t be too critical about the path I chose. After all, I didn’t know what I didn’t know.
Also, that path led me to something much better. More on this shortly.
Because of the indicators I was using back then, I wasn’t getting to know the chartsor how price ebbs and flows around key levels. I was just clicking buttons because a few squiggly lines said it was time to buy or sell.
That’s a problem, isn’t it?
It was for me, and my deteriorating account balance was proof.
When I think back on the experience today, it amazes me that I didn’t blow more trading accounts. And believe me, I went through a few between 2007 and 2010 to get where I am today.
Don’t get me wrong. I’m not saying all indicators are bad or that those who use them are wrong to do so. Even I use two moving averages which we’ll get to later in the lesson.
But to rely solely on them without first learning how to read price action is a mistake.
That’s just my opinion but having been involved with trading since 2002, I can tell you that there’s no better indicator than raw price action.
It has the most direct relationship with market participants and is the least lagging of the bunch.
2. Indicators Are Condition-Dependent
You’ve no doubt come across one of the sales pages for a Forex trading robot, or Expert Advisor (EA) as it’s called in MetaTrader.
In fact, if you’ve been in the business for a while chances are you’ve seen quite a few of these offers.
What’s curious is that they all seem to be promoting the same thing – a high win rate.
I always find that odd considering a high win rate is entirely unnecessary. Sure, it makes you feel good to win, but a ratio of wins to losses is 100% inconsequential on its own.
As George Soros famously said…
It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.
But that’s a topic for another time. For now, I want to focus on the sales pages for those trading robots I mentioned.
How in the heck do they achieve those win rates? After all, most of them are backed up by something like Myfxbook.
Well, I’ll tell you how they do it…
The developer designs the EA to function in a particular market condition. Yep, they rig it, so the performance stats look great, but the robot is entirely dependent on specific conditions.
That’s why most of them only work on certain currency pairs – because the developer designed it to look good on only those pairs.
Perhaps it’s been tailored to range bound price action or only works in a trending market.
But what happens when those conditions change?
You guessed it. The EA stops performing. That $500 piece of software is now obsolete, and you’re left searching for a new trading strategy a bit poorer than you were before.
Oh, and if you’re wondering what the other half of those developers do to get a high win rate, the answer is they cheat.
Yep, the performance is pure fabrication. There may be a few that are legitimate and can work with a few modifications, but the vast majority fail over an extended period.
How do I know this?
Having been a trader since 2002 and solely involved in currencies since 2007, I’ve done my share of research. I’ve also had the opportunity to connect with traders whose experience far exceeds that of my own.
I may get some hate mail for what I just said, but that’s okay. Those who have been around the block know that what I say is true.
The key takeaway here is that indicator-based strategies will always be condition dependent. If it’s designed to work in a trending market, it will likely blow your account when that market begins to consolidate.
Even the large hedge funds aren’t immune to this. It’s why some go out of business after years of turning a profit. And those who make it pay millions of dollars to have their algorithms fine-tuned so that they don’t go bust.
But do you know what isn’t dependent on market conditions?
Simple yet effective strategies like the pin bar, inside bar and engulfing patterns have worked for decades and will continue to be effective for years to come.
And if you construct a sound strategy for managing risk, they can serve you very well over the course of your lifetime.
Sure, you may have to stay on the sideline occasionally. But once you know what to look for, these price action strategies work regardless of whether markets are range bound or trending.
Even chart patterns like ascending and descending channels, wedges and the head and shoulders have been around for ages.
Why is that? Why do indicator-based strategies have a limited shelf life while price action lives on?
Let’s find out!
3. Psychology Is King
Psychology drives markets.Gather millions of people from around the world, give them access to a computer and ask whether they think a currency is too high or too low.
That’s the Forex market in a nutshell.
Of course, we all know that profiting from it is another matter entirely. But deciding whether we think a pair is likely to move higher or lower is all we’re doing. That’s what each of us is doing when we buy or sell a currency pair.
And in a collective sense, what market participants do is illustrated via the price action on your charts.
Now, what happens when the EURUSD approaches a level that has acted as resistance for the past six months?
If it’s an obvious level, chances are it will attract sellers.
Everyone can see that same resistance level. You may not have it marked on your chart or see it in time to take advantage of it, but it’s there.
It doesn’t matter whether you’re using a MACD, RSI, Stochastics, moving averages or some fancy combination of proprietary indicators.
The key support and resistance levels are there for everyone to see and use.
But while the price action is the same for everyone, the indicator combinations are far from it.
Let me ask you something…
How many indicators are there?
500? 1,000? Maybe 5,000?
There is no number. It’s infinite considering you can code to your heart’s desire using something like MetaTrader’s MQL.
That’s an issue, right?
Your indicators are telling you one thing while the next trader sees something completely different.
For the price action trader, that resistance level on the EURUSD is universal. There are no variables like indicators to get in the way.
And as I mentioned above, things can get dicey when the market decides to stop trending. Because if you designed your indicator-based strategy to work in a trending market, it’s going to fail when markets begin to consolidate.
But once again, the price action trader isn’t phased. It doesn’t matter if the market is trending or range bound, the psychological support and resistance levels will always tell the real story.
At the end of the day, that’s all you need to become profitable.
4. Indicators Overcomplicate a Simple Process
Trading the Forex market for consistent profits is not complicated, or at least it doesn’t have to be. Those who have taken my course and are part of the Daily Price Action community know this.
But that doesn’t stop most traders from overcomplicating things.
Just look at how MetaTrader – arguably the most popular Forex trading platform – starts traders on their journey.
The chart above was taken directly from a new MetaTrader demo account. Not all platforms start out this way but the vast majority default to some combination of indicators.
You know what’s ironic? The name of the template above is “popular.”
If that is indeed a popular template, it’s no wonder most Forex traders struggle, especially in the first year.
Now, don’t get me wrong. All technical indicators are not necessarily bad. I don’t want to give them a universal label like that.
The issue is that many traders abuse them. They add four or five indicators to their chart, watch for crossovers or oversold and overbought conditions and then pull the trigger.
The thing is, they don’t even know what they’re buying or selling.
Those same traders tend to get frustrated when they don’t see some form of consistent profits after a month or two.
So what do they do?
They begin looking for a new indicator or perhaps an entirely new trading strategy. And given the infinite number of indicator combinations out there, it’s no wonder so many never find what they’re looking for.
It’s a vicious cycle.
But I’m not judging. This is not a me versus you post because I’ve been where you are now.
What’s the real issue?
Any new endeavor has a learning curve. Some might be a few weeks while others can take a few years. For most, trading falls into the latter half of that range.
One of the issues with using a trading system built around indicators is that trying to pinpoint the problem is an uphill battle.
Let’s assume Frank has been using a trading system that utilizes the MACD, RSI and four moving averages. He’s been trading for a few months but has only losses to show for his efforts.
But Frank is determined to make it work, so he decides to deconstruct the strategy to try to isolate the problem. His goal is to figure out if it’s the MACD, RSI or any one of the moving averages that’s causing the issues. Perhaps it’s even a combination of these indicators.
Talk about problems…
I don’t envy Frank one bit in this situation. There are hundreds if not thousands of technical indicators available for the MetaTrader platform.
So he’s now supposed to go out and sift through thousands of options to find the one that works? Who knows if the strategy he’s employing will work regardless of the indicators he uses.
What’s worse is that it will take him at least a month or two to figure out if the new addition is useful.
I speak from experience here. My first three years in the Forex market (2007 to 2010) were spent testing various indicator-based strategies.
It was a painful grind. The only reason I made it through is that I was obsessively passionate about trading and stubborn enough to see it through.
A simple solution
The way to untangle the mess of indicators on your chart is quite simple yet highly contested by most traders, particularly those just starting out in the business.
The solution is to remove every indicator from your chart.
Yes, all of them! Even the coveted MACD or RSI has to go.
You can add one or two indicators later, but not until you fully understand what’s happening with the price action on your chart. Otherwise, you won’t know if they’re actually adding value or if you just like them because they look cool.
Let’s face it; most new traders choose indicators based on how they look, not their function or added value. That’s what I used to do.
Take it from me. Until you can read the raw price action on your chart, you have no business adding indicators.
Some will argue this point, and that’s okay. Everyone is entitled to an opinion.
But after more than 15 years of trading financial markets and teaching thousands of traders, I can tell you that adding indicators before understanding price action is a mistake.
The Two Technical Indicators I Use
Yes, even I use technical indicators. But before you start thinking I’ve been hypocritical up to this point, let me explain what I use and why.
As you may well know, I favor the 10 and 20 exponential moving averages (EMAs). Those are the only two indicators I use. You will never see any MACDs or RSIs on any of my charts.
Why the 10 and 20 EMAs, you ask?
I primarily use these moving averages as a way to identify the mean. So let’s run through that for a moment to clear up any confusion.
In math, the mean is the average of a set of numbers. It’s the “central” value of any set of numbers.
So if we had the set of numbers 1, 2, 3, and 4, the mean would be 2.5.
We get that by adding the four numbers together and dividing by four. It would look like this (1+2+3+4) / 4 = 2.5.
What does this have to do with the markets?
Everything! Financial markets are just the visual representation of what happens when math and psychology collide.
Every market regardless of whether it’s stocks, currencies, commodities or something else has a mean. Moreover, every market always returns to the mean.
That isn’t a possibility or even a probability; it’s a mathematical certainty.
With this in mind, I use the area between the 10 and 20 EMAs as the mean during a trend. This keeps me from buying too high or selling too low.
Here’s an example from the AUDUSD daily chart.
For teaching purposes, I’ve exaggerated the area between the 10 and 20 EMAs you see in the chart above. But notice how price returns to the mean before making the next move higher or lower.
The concept of mean reversion is one of my broad-based rules for entering a trade. If a pair is too far from its central point, I will stay on the sideline regardless of how appealing the rest of the setup may be.
The Ironic Evolution of a Price Action Trader
There is a universal satire about the evolution of humans. The image usually depicts a baby turning into a grown man and later becoming elderly.
The irony is that in many ways, we end life how we started it.
In a similar but not so serious vein, price action traders are the same. We start out not knowing anything about indicators, so we set off on a mission to learn everything there is to know about them.
But somewhere along the way, we get frustrated enough to purge our charts of the clutter.
After all the struggle, we end up right where we started.
The only difference is we go from not knowing anything about indicators to not caring much about them. They become a distraction and a nuisance rather than an advantage or a benefit.
You know why?
It’s because everything you need to know is right in front of you. It has been the whole time.
I can’t see your charts, but I know it’s there. All you have to do is pull back the proverbial curtain, and you’ll see it too.
If you want to become a great price action trader, a clean chart is a must. Otherwise, you’ll end up spending your time sifting through useless technical indicators rather than learning to read the activity on your chart.
Attempting to troubleshoot complex indicator-based strategies is a nightmare. By using simple price action strategies, you’ll reduce the learning curve by half if not more.
If you feel deep down inside that indicators are the way to go, that’s okay. Just be sure to spend some time learning how to read price action. It’ll undoubtedly help you in the long run even if you decide to use an indicator-based strategy.
Whatever you do, keep it simple. Learning how to trade Forex doesn’t need to be a complicated process. In fact, it should be just the opposite.
Master one or two price action strategies at a time. Incorporate indicators if you’d like, but remember that price action is all you need to become consistently profitable.
All you need is one pattern to make a living.