Most indicators are only useful for providing information about one aspect of the market. For example, ADX and moving averages provide information about the general trend, while stochastic and RSI provide information about momentum. For this reason, trading systems that incorporate more than one indicator are usually more successful than single indicator systems. This article will provide some ideas for how to trade using multiple indicators.
Before an indicator can be combined with others into a system, its type needs to be understood. Combining indicators of the same type often leads to the same signal being repeated. That can cause a trader to misidentify the strength of the signal being given. The best trading systems combine indicators of different types.
Here is a list of indicator types, along with some examples of indicators that fit into each category:
Momentum indicators measure the speed at which price is moving. This allows a trader to determine whether a currency pair is overbought or oversold. This category includes RSI, Stochastic, and Commodity Channel Index (CCI) amongst others. MACD can be used as either a momentum or trend indicator.
Trend indicators measure whether the market is trending or ranging. They also sometimes measure the direction of the trend. This allows a trader to catch breakouts early, when potential profits are the greatest. ADX, moving averages, and Parabolic SAR are examples of pure trend indicators. MACD can be used as either a trend or momentum indicator. Bollinger bands can also be used as either a trend or volatility indicator.
Volatility indicators measure how quickly the price is moving up or down. This allows traders to catch breakouts when volatility increases. Envelopes and Average True Range are examples of volatility indicators. Bollinger bands can also be placed in this category.
Trading using multiple indicators
Here are two examples of systems that incorporate multiple indicators:
Bollinger bands and Stochastic
When Stochastic is below 20%, the currency pair is considered to be “oversold.” When it is above 80%, it is considered to be “overbought.” However, Stochastic by itself can often give false signals. This is because currencies often remain overbought or oversold for long periods before they finally reverse.
Using Bollinger bands by itself can also result in false signals. Sometimes buying when the price hits the bottom band and selling when the price hits the top band is profitable. Other times, the price hits the top or bottom band because the price is breaking out of a range, resulting in a crushing loss for anyone who thought it would return to the middle band quickly.
If a trader combines Bollinger bands with Stochastic though, it can result in less false signals. Here is an example:
In this chart, the price hit the top of the upper band at around 9:45 a.m., giving a sell signal. But Stochastic showed the pair was not overbought, since it was not above 80%. Having stochastic as an additional indicator could have allowed a trader to avoid losses here.
Moving averages and RSI
Moving averages and RSI can also give false signals by themselves but work better when combined with each other. In this case, a trader can use a moving average crossover as a sell signal, but exclude cases where RSI is not below 50. A similar strategy can be used for buy signals if the trader excludes signals where RSI is not above 50.
Using multiple indicators often leads to more success when compared to using just one. But traders need to only add indicators that provide new information. Using more than one indicator of the same type should be avoided if possible. This is how one can trade using multiple indicators.