Back to BlogTrading Indicators – Are They Effective?
Trading markets can be very complex and carry many challenges. As trading is very subjective in nature, traders often employ a variety of strategies and trading tools. These in combination can assist day traders to make more informed decisions when using trading indicators. Trading indicators are mathematical calculations that, depending on the indicator, make visual estimations on historical volume, price and interest data that attempt to forecast future price movements. These trading indicators can be used for cryptocurrency, forex, commodities and are often used on TradingView or MetaTrader.
There is great debate as to the effectiveness of trading indicators. This article written by Market Spotter aims to deep dive into the effectiveness of trading indicators, drawing on a range of indicators and their role in trading strategies.
Moving Averages
Moving Averages are one of the most widely used trading indicators. They simply smooth price data of a specified period of time, therefore helping traders identify trends and dynamic support and resistance. There have been extensive studies on the effectiveness of moving averages in trend identification. One particular study revealed that Simple Moving Averages can be effective in identifying trends and contrarian strategies (Andrew Lo & Craig Mackinlay, 1990). It is important to note that moving averages are lagging indicators, and sideway/choppy markets may affect performance when identifying trends. Let’s now explore the Fibonacci Retracement indicator.
Fibonacci Retracement
The Fibonacci Retracement indicator is solely based on a sequence of numbers that appear in a multitude of aspects of nature. These fibonacci levels are used to identify potential support and resistance levels, and when used give rise to a grid like structure. Studies have suggested that fibonacci levels can be effective in predicting future price reversals (Carolyn Boroden, 2008). However, it is important to note that in volatile markets these levels may not support the price, and the interpretation of the indicator is subjective to each trader. This is where a combination of indicators are useful when seeking confirmation of the fibonacci retracement indicator. Moving onto the Relative Strength Index indicator.
Relative Strength Index (RSI)
The Relative Strength Index (RSI) is another common indicator when identifying oversold and overbought conditions in any market. The importance of the two conditions are evident as when the RSI displays that an asset is overbought or oversold, this may give rise to a pivotal point in the market direction.
Studies have shown whilst it is effective in identifying trend reversals, no indicators are fool proof and the RSI may become limited in strong trending markets (Darryl Winters & Yi Wu, 2007). This highlights the importance of using multiple indicators when trading.
Conclusion
In summary, there is no perfect indicator that performs 100% of the time; their effectiveness depends on the interpretation of the indicators and market conditions. Indicators therefore, should be considered as a tool kit and this is why Market Spotter was created. To create an array of trading indicators and enable traders to easily interpret them.
References
1 – Lo, A & MacKinlay, A (1990) ‘When Are Contrarian Profits Due to Stock Market Overreaction?’ The Review of Financial Studies, 3(2) pp 175-205.
2 – Colby, R & Meyers, T (1988) ‘The Encyclopedia Of Technical Market Indicators’ McGraw-Hill.
3 – Boroden, C (2008) ‘Fibonacci Trading: How to Master the Time and Price Advantage’ McGraw-Hill.
4 – Winters, D & Wu, Y (2007) ‘An Empirical Study of Technical Analysis. The Journal of Business, 80(4) pp 1351-1386.
