Another New Indicator? – 4 Key Questions to ask
Invariably, the motivation to look at adding another technical indicator beyond that which you are already using, is a belief that your trading results, and the system that creates these, could be improved.
As traders, we are bombarded with information relating to the use of technical indicators to guide decision making in our entry and exit decisions. Such information can be “persuasive” in making a change but as you are responsible for your trading decisions and subsequent results, it seems logical to start the process by asking the question “is it the right time for me to explore the use of another indicator?”.
The aim of this article is to highlight the FOUR critical questions you should ask of yourself first.
1. Am I REALLY trading my existing system NOW?
As previously referenced, the major impetus for considering adding an indicator is to improve results when trading an existing system. You can only make the judgement of any improvement if you both have a comprehensive system that specifies entry/exit/position sizing as a minimum AND are actually trading this.
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The reality for most traders is that they fall down on one or both of these two CRUCIAL factors. Honesty with what you are doing now backed up with the evidence of journaling will give you the answer to this.
If these resonate with you, logically addressing these should be your priority. Without this, you are not able to make that judgement and hence adding another indicator is far less likely to impact positively on results.
2. Is adding another indicator the ONE major thing that is going to make the most difference to my trading results NOW or is there something else I should invest my energy on?
We have already specified two potential priorities in the previous point with reference to your trading plan and adherence to it. Also, we referenced the issue of evidence through journaling. As this is not only crucial for the above point, it is a vital part of your review process should you choose to investigate the use of a new indicator. So again, could be viewed as a priority.
Finally, addressing your knowledge relating to trading may be more important for you now. Not only are we referring to general trading learning but an in-depth understanding of what indicators including the ones you are using now, do and do not tell you about market sentiment. This learning is again important in your judgement as to which NEW indicator could be useful.
Therefore, again we would suggest this could be a priority over adding another indicator right now for you.
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Prioritise your trading plan, discipline, journaling and learning, making sure these are at an appropriate level for you to invest time in exploring new indicators.
3. Have I got absolute clarity about what another indicator should do to enhance my existing system?
Previous points relating to journaling and learning should give you the ability to more ably identify what it is that a new indicator could add to your trading.
The first decision in this process is to identify whether your focus is on improving entry or exit.
Once you have clarified this and If you have ticked other boxes so far, the other potential area for exploration is to look at the perimeters of the indicators/systems you are currently using as it may be that this could simply be the answer to create potentially better outcomes.
For example, let’s assume you are using a price/10 EMA cross as an exit signal. You have found that one of the areas you wish to improve has not been taken out early on a regular basis by “market noise”. It may be a simple case of testing a change e.g. to a price 20EMA cross that may make the difference you are seeking.
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• Learn about the indicator you are using and make sure it is a fit for any gap you have identified in your existing system.
• Don’t forget it may serve your purpose to look at a simple adjustment of perimeters of existing indicators you are using. This STILL needs testing before implementation.
4. Have I got a formal process for testing an additional indicator in place that will produce the evidence to decide whether to include it within your trading plan?
Ok so you have got this far, and so are ready to look at your new indicator. So briefly here are three process components you need to have in place.
i. Perform a back-test on previous trades to determine any change in dollar outcome across a critical mass of trades, Remember the purpose of any back-test is to justify the need for a forward or prospective test, NOT to change your system at this point.
ii. Perform a prospective test (again deciding what critical mass of trades are enough on which to make a judgement) on a demo account using the indicator as you intend to do so in live trading. This may not only reinforce information from your back-test but adds the reality of new data coming into the market live and the tests the trades you may not have taken (if your previous entry indicators would have blocked action). It is important that you keep ALL other trading plan perimeters the same to be able to confirm that it is your new indicator that is making any difference observed.
iii. If your test produces a positive outcome, then articulate within your trading plan how you are going to use your new indicator. It is important that you ensure any statements are sufficiently specific (see an article on this HERE) to guide action and measurement, and this should include under what market circumstances you would use it.
iv. Set a review date (e.g. 3 months) to determine how beneficial its continued use has been.
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Ensure your process is not only clear but one you adhere to. You may use the above as a start point to developing you on process but remember to specify how many trades YOU think is a critical mass on which to make decisions.
We trust this has been useful and as always please feel free to ask questions of our team or email to mike.smith@gomarkets.com with your comments.