Lesson 4 of 5
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Using indicators (6)

Phillip Konchar

 

How traders use indicators:

Indicators help traders fulfil three basic functions:

Alert
Indicators can alert traders to a change in a trend. If the momentum of a trend is weakening, it could finish soon.
Confirm
Indicators can be used to confirm price action. For instance, to confirm a trend has finished.
Predict
Using indicators to predict is aggressive but it can be used to predict changes to a trend.

How indicators should be used:

Regardless of what it is used for – alert, confirm or predict – a trader should never put all their faith in an indicator. When they do use one they should know it inside out. Take a holistic approach and use the most popular indicators in the market to gain the best picture possible.

We use lagging indicators to confirm a trend is really happening. Once the trend is established, the leading indicators are used to find overextended market conditions – potential turning points.

It is considered dangerous to trade a leading indicator signal against the prevailing trend of a market.

In an upward prevailing trend, it is best to look for buying setups via oversold signals from a leading indicator. In a downward prevailing trend it is the opposite, look for selling setups via overbought signals from a leading indicator.

Readings from indicators have different meanings in different circumstances. By using other analysis techniques, as well as indicators, we’re building up the evidence towards placing a trade.

Key Learning Points
  • Indicators help traders perform three functions: alert, confirm or predict.
  • Generally, lagging indicators should be used to confirm a trend.
  • Then, oversold signals from leading indicators are used to buy into an uptrend and overbought signals to sell into a downtrend. This is trend following trading.
  • Don’t put all your faith in an indicator or set of indicators, use it or them to analyse the market holistically.

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