Indicators – Great Tool or Totally Useless?

If you are new to trading, you have heard the term “indicator” and that they are vital tools for traders. Well, maybe. Sometimes. In my opinion, there is a lot of misunderstandings about indicators and far too much confidence in them.

That is way I am now starting a little series of articles on indicators, both here on the blog and on Medium. On Medium, I will do more of an introduction or overview of them and here on the blog, I will go into more detail of how they can be used and how I use them.

What is important to know is that all indicators are derived from price data. Some indicators allow use volume. But the thing is that you already have the price data on the chart, all indicators do is to recalculate that data and present it in another form.

Years ago, I was told by a seasoned trader who didn’t use indicators at all, that you could always look at price and estimate the indicator but not the other way around. That is very true, you can. And with that argument, you would think that indicators are useless. Well they can be, but they can also not be. Confused yet?

What I mean is that price is what matters. Add volume to that and you have all you need to trade. But indicators can be very useful to identify trends and potential turns in price. Although you can use price data for this, indicators usually make it much easier to see these things. They can make it easier to identify trends by cutting out the “noise”.

This post is just a teaser of the article series. Right now I am working on the first, which will be about the Relative Strength Indicator (RSI). It is one of the most commonly used and also one of the most misused indicators.

One thing I would like to emphasize is that indicators just “indicate”. They should not be used as buy and sell signal. I use them to scan for interesting stock and setups. Buy and sell decisions are based on price and volume. Only and always!

Setting Strategy Goals

”Sound strategy starts with having the right goal.”

-Michel Porter

We need to set goals for our trading. We need them so that we can evaluate our trading and become better traders. But what is a good goal and how do we evaluate and measure them?

Bad Strategy Goals

It is easy to set a monetary goal for a trading strategy. Perhaps making $10 per day or $1,000 per month. It makes sense at first. If you have expenses of $1,000 per month why not have a goal of making at least that amount?

I did this in the beginning of my trading career. I used to sit and think that if I made 1% per day with a starting capital of £1,000, how much would I have at the end of they year. Then I would do the calculation in Excel and come up with a nice little sum of £12,032 or 1,103% (assuming 250 trading days).*

Wow, what if I could make 1.2% per day? Then I would have £19,730 or 1,873%. All very impressive numbers but not realistic. Trading just doesn’t work like that; it isn’t that consistent. There will be losing days, losing weeks and losing months. Any losing streak will kill a strategy based on short term returns.

There is nothing wrong with having a monetary target as an overall goal. A million in five years or ten million before I am 50 are great motivators to get you out of bed in the morning, but for strategy goals they are useless.

Good Strategy Goals

What is a good strategy goal then? Most traders think in terms of performance instead of result. I know what you are thinking, but no, they are not the same. Results are monetary goals while performance goals are more of the type: risk vs reward, minimising drawdown or volatility of the P/L (profit/loss).

Another type of goal could be to simply improve over time. Am I better now than I were one year ago? If not, then why? If yes, then also why? That is one of my goals. I want to see that I am improving as a trader over time. These days it is more or less my only goal. If I am constantly improving, then I know I will increase my profits.

Another good goal could be to stick to the trading plan. Sounds simple but it really isn’t, especially in the beginning. I used to do deviate from my plan a lot as a newbie. Then when I looked at my trades, I could see that my worst trades were those where I had abandoned my plan just because I thought I saw something good in the charts.

If you have a plan that says that you should take trades when two moving average cross with increasing volume, then those are the trades you should take, not the ones where someone said something on Twitter.

Trading Goal for Newbies

Here are a few specific goals you can try out. You can have more than one goal as long as they are not conflicting with each other (I don’t any of these conflict).  Pick a few of them and stick to them. If you find that you are not able to, then ask yourself why. Was it because the goal was too hard or because I just deviated from my plan? Perhaps the goal just wasn’t a good goal for me to have right now.

• Follow the trading plan to the letter. DO NOT TAKE TRADE THAT ISN’T IN THE PLAYBOOK!
• Have a risk to reward ratio of a minim of x to 1. It could 2 to 1, 3 to 1 or whatever, but if you see a trade with a 2 to 1 ratio and your minimum is 5 to 1, then don’t take the trade.
• To have a win rate of x% over a longer period. This depends heavily on your type of trading and you need many trades to evaluate since trading is a streaky business.
• Limit losses by setting stops and sticking to them.
• Improve over time. Make sure that your win rate, draw downs, P/L volatility and result improve over time and or number of trades. The goal is to become a better trader; to become a great trader.

There is the old “SMART” acronym, Specific, Measurable, Attainable, Relevant and Time. Sure, I agree with that, but not all goal can be. The goal “to become a better trader” isn’t very specific, but very important in my book. It may or may not be measurable (results are just one aspect of improvement).

Updating Goals

After you have traded a while and you have a number of trades (at least 200 in my opinion), then you can analyse that data and come up with new goals. If you see that you make 5% per trade on average, on certain type of trade, then your goal should be to take more of those trades.

If you see that your drawdown was too big then your goal should be to limit drawdowns from here on.

You and your trading evolve over time and so should your goals. The goals that you had as a beginner might not be as relevant after a few years of experience (but they could still be of course).

But don’t spend hours on goal setting. Just pick one or two and then focus on working out a trading plan, study the markets, study the charts and trade. The best way to improve is to just do it. Trade – evaluate – repeat. That’s the magic sauce!

 

My First Article on Medium

 Just published my first article on Medium. All part of my endevour to battle my dyslexia. 

I could just post everything I write here but this is a brand new blog and has very few visitors (actually it doesn't have any yet). Also, but publishing my work on other plattforms I force myself to really edit my text and work on my writing, just to meet their criteria and guidlines.

The article is titled; Four Trading Insights for Beginner Traders. I write about three "issues" that I think a beginner trader should talk about before he or she start to trade.

First, that it is importarnt to have an income on the side. This to not having to take out money of the trading account. You want to make your trading account grow, not shrink.

Second, that you should be prepared to work very hard if you want to make it as a trader. Lazy people don't make good traders.

Third, is that you must understand that you will lose money in the beginning and that is totally normal. I beliver many trader quit after a few losses because you cannot take losing money. But you have to be able to take it, it is part of the game.

And lastly that you shoul never be satisfied with where you are to day. Always strive to become better and never stop learning new things. 

That was a very brief summary. If you want to read the whole article you can so here.

Four Trading Insights for Beginner Traders

The url actually says "three" instead of four insights. That's dyslexia for you :)