So, you have been using a certain indicator for a certain amount of time now. You even use the technical indicator to find the entry points or show you the overall trend. My question is “how well do you know the function of the indicator?”
It is good to have an understanding of how the indicator calculates the data, the mathematical equation required. Fortunately, we have the computer to do all of that for us. Also, knowing it doesn’t really make you a better trader, but it is good for some foundation of knowledge.
Function and Maintenance
Understanding your technical indicator is like driving a car. You don’t need to understand the physics of the combustion engine. You just need to learn how to drive and it will take you from point A to point B.
But wait, it is not that simple. So you know how to drive, what would happen if you don’t know the basic function/maintenance of your car? Your car would break down, right? You don’t just keep driving. You need to maintain your oil, water, petrol, batteries, etc…
Using any technical indicator is like using a car. You just can’t use it all the time without ever maintaining it. A technical indicator requires a similar approach like maintaining a car. In a car, you need to know when you change your tyres, add petrol, change the oil, add water, etc... Using a technical indicator, you need to know when to use it and when not to use it.
Oh, I know your situation because I personally been there too. You know, one week you make 500pips. Then the following week, you lose the 500 pips or more. Make 100 pips in one trade. Then you lose 100 pips or more in the following trade. And I’m excluding all the emotional aspects. Meaning, you are much disciplined to follow the indicator and exclude all emotion based decisions, leaving all the decisions on the indicator.
Address the problem
You need to understand the capabilities and limitations of the technical indicator. No doubt, you have made winning trades using your forex trading system. And you also made losing trades using the same indicator or the same forex trading system.
Do you know the limitations of the technical indicators? Understanding your losing trades is more important than understanding your winning trades. It may sound like focusing on the negative, but why is this? Because a technical indicator was designed to produce a more favourable odds to the trader.
You see, a technical indicator is around 60-80% correct most of the time. And 20-40% wrong most of the other time. So, why would you try to concentrate on the 60-80% wining trades? Stop fixing what’s not broken. You can’t increase the winning signals, it is at a default of 60-80%. But the 20-40% losing signals, well you can decrease it by avoiding it.
Thus, decreasing your losing trades means retaining more of your profits. It means less emotional rollercoaster stress to keep you sane for another day of trading.
Understanding the limitation and the flaws
You can’t fix a problem if you are not aware that the problem exists. Time and time again, traders don’t know what the problem is. This is what the traders’ know for a fact:
1. Technical indicators are not 100% correct all the time.
2. Technical indicators are lagging.
There is a big difference between “Knowing” and “Understanding”. Everyone knows point 1 and 2, but they don’t understand it. Point 1 and 2 sounds too simple enough, but do you understand the “Why?” Why are technical indicators not 100% all the time? And why are the technical indicators lagging?
Here’s why (pay close attention here):
Technical indicators calculate historical data. It cannot produce any result without first some data, hence the term ‘lagging’ because it is delayed information.
It is designed to detect a trend. When a shift in a trend occurs, the technical indicator cannot detect the shift straight away because it requires more data to confirm the shift in the trend.
So what does that mean? It means that in a consolidating market (market going sideways) the indicator doesn’t have enough time to calculate and produce a trend. Example: When the market is going up the indicator shows up. When market shifts down there is a delay in the indicator. The market then shifts up and then the indicator would only then starts to shows down (false signal). The moment the market shifts down again, the indicator would only be catching up and would indicate up (another false signal).
90% of losing trades occur during consolidating times. This is the time when technical indicators gets chaotic and starts to produce the false signals. Some of you may know this already and maybe even telling yourself that I’m stating the obvious. Of course, you have the right to think that… because I haven’t even made my point yet
Conclusion - Crucial Factor
Here’s my point: Being aware of this flaw within your forex trading strategy system, wouldn’t it make your trading system more powerful when you get informed before a consolidating market occurs? To know when ‘NOT’ to trade because the risk of trading and losing your trades are very high is just logical.
Avoiding consolidating times will reduce your losing trades. As with trade management, usually 1 losing trade requires 2 or more winning trades to breakeven and return your capital. It is very important to avoid losing trades.
Avoiding consolidation is very hard because a technical indicator will never inform you in advance. Traders are already caught within the consolidation and have lost trades before they realize it. Even Swing trading are no match to a consolidating market.
I’ve seen many forex trading strategy system that doesn’t address this major and crucial issue. Not one that I’ve come across that address’ this problem. So my advice when you create your own system, try to address this big problem; “How can I make the indicators warn me of an impending consolidation?”
Once you answer this question, you will take you trading to a whole new plateau.
Wishing you all the best with your Forex trading,
Breian Malupa
PS. Stay tuned for my next post on
“How, why and when do consolidating times occur the most.”