Many investors and active traders use technical trading indicators to help identify high probability trade entry and exit points. Hundreds of indicators are available on most trading platforms, therefore, it is easy to use too many indicators or to use them inefficiently. This article will explain how to select multiple indicators, how to avoid information overload and how to optimize indicators to most effectively take advantage of these technical analysis tools.
TUTORIAL: Technical Analysis

Using Multiple Indicators
Types of Indicators
Technical indicators are mathematical calculations based on a trading instrument's past and current price and/or volume activity. Technical analysts use this information to evaluate historical performance and to predict future prices. Indicators do not specifically provide any buy and sell signals; a trader must interpret the signals to determine trade entry and exit points that conform to his or her own unique trading style. Several different types of indicators exist, including those that interpret trend, momentum, volatility and volume. (For related reading, see The Pioneers Of Technical Analysis.)

Avoiding Redundancy
"Multicollinearity" is a statistical term that refers to the multiple counting of the same information. This is a common problem in technical analysis that occurs when the same types of indicators are applied to one chart. The results create redundant signals that can be misleading. Some traders intentionally apply multiple indicators of the same type, in the hopes of finding confirmation for an expected price move. In reality, however, multicollinearity can make other variables appear less important and can make it difficult to accurately evaluate market conditions.

Figure 1
Chart created with TradeStation.

Using Complementary Indicators
To avoid the problems associated with multicollinearity, traders should select indicators that work well with, or complement, each other without providing redundant results. This can be achieved by applying different types of indicators to a chart. A trader could use one momentum and one trend indicator; for example, a Stochastic oscillator (a momentum indicator) and an Average Directional Index (ADX; a trend indicator). Figure 1 shows a chart with both of these indicators applied. Note how the indicators provide different information. Since each provides a different interpretation of market conditions, one may be used to confirm the other. (For related reading on the Stochastic oscillator, see Stochastics: An Accurate Buy And Sell Indicator.)

Keep Trading Charts Clean
Keeping Charts Clean
Since a trader's charting platform is his or her portal to the markets, it is important that the charts enhance, and not hinder, a trader's market analysis. Easy to read charts and workspaces (the entire screen, including charts, news feeds, order entry windows, etc.,) can improve a trader's situational awareness, allowing the trader to rapidly decipher and respond to market activity. Most trading platforms allow for a great degree of customization regarding chart color and design, from the background color and the style and color of a moving average, to the size, color and font of the words that appear on the chart. Setting up clean and visually appealing charts and workspaces helps traders use indicators effectively.

Information Overload
Many of today's traders use multiple monitors in order to display several charts and order entry windows. Even if six monitors are used, it should not be considered a green light to devote every square inch of screen space to technical indicators. Information overload occurs when a trader attempts to interpret so much data that all of it essentially becomes lost. Some people refer to this as analysis paralysis; if too much information is presented, the trader will likely be left unable to respond.

One method of avoiding information overload is to eliminate any extraneous indicators from a workspace; if you're not using it, lose it - this will help cut down on clutter. Traders can also review charts to confirm that they are not being encumbered by multicollinearity; if multiple indicators of the same type are present on the same chart, one or more indicator can be removed. (For related reading, see How Market Psychology Drives Technical Indicators.)

Tips for Organizing
Creating a well organized workspace that uses only relevant analysis tools is a process. The quiver of technical indicators that a trader uses may change from time to time, depending on market conditions, strategies being employed and trading style.

Figure 2
Chart created with TradeStation.

Charts, on the other hand, can be saved once they are set up in a user-friendly manner. It is not necessary to reformat the charts each time the trading platform is closed and reopened (see the trading platform's Help section for directions). Trading symbols can be changed, along with any technical indicators, without disrupting the color scheme and layout of the workspace.

Figure 2 illustrates a well-organized workspace. Considerations for creating easy to read charts and workspaces include:

  • Colors. Colors should be easy to view and provide plenty of contrast so that all data can be readily viewed. In addition, one background color can be used for order entry charts (the chart that is used for trade entry and exits), and a different background color can be used for all other charts of the same symbol. If more than one symbol is being traded, a different background color for each symbol can be used to make it easier to isolate data.
  • Layout. Having more than one monitor is helpful in creating an easy to use workspace. One monitor can be used for order entry while the other can be used for price charts. If the same indicator is used on more than one chart, it is a good idea to place like indicators in the same location on each chart, using the same colors. This makes it easier to find and interpret market activity on separate charts.
  • Sizing and Fonts. Bold and crisp fonts allow traders to read numbers and words with greater ease. Like colors and layout, font style is a preference, and traders can experiment with different styles and sizes to find the combination that creates the most visually pleasing outcome. Once comfortable lettering has been found, the same style and size fonts can be used on all charts to provide continuity.

Optimizing Indicators
User Defined Input Variables
It is up to each trader to decide which technical indicators to use, as well as to determine how best to use the indicators. Most commonly available indicators, such as moving averages and oscillators, allow for an element of customization simply by changing input values, the user-defined variables that modify the behavior of the indicator. Variables such as look-back period or the type of price data used in a calculation, can be altered to give an indicator much different values and point out different market conditions.

Figure 3 shows an example of the types of input variables that can be adjusted to alter an indicator's behavior. (For related reading on moving averages, see 7 Pitfalls Of Moving Averages.)

Figure 3
Chart created with TradeStation.

Many of today's advanced trading platforms allow traders to perform optimization studies to determine the input that results in the optimal performance. Traders can enter a range for a specified input, such as a moving average length, for example, and the platform will perform the calculations to find the input that creates the most favorable results. Multivariable optimizations analyze two or more inputs simultaneously to establish what combination of variables lead to the best results. Optimization is an important step in developing an objective strategy that defines trade entry, exit and money management rules.

While optimization studies can help traders identify the most profitable inputs, over-optimizing can create a situation where theoretical results look fantastic, but live trading results will suffer because the system has been tweaked to perform well only on a certain, historical data set. While outside the scope of this article, traders who perform optimization studies should be careful to avoid over-optimization by understanding and utilizing proper backtesting and forward testing techniques as part of an overall strategy development process.

The Bottom Line
It's important to note that technical analysis deals in probabilities rather than certainties. There is no combination of indicators that will accurately predict the markets' moves 100% of the time. While too many indicators, or the incorrect use of indicators, can blur a trader's view of the markets, traders who use technical indicators carefully and effectively can more accurately pinpoint high-probability trading set-ups, increasing their odds of success in the markets. (For related reading, see How Market Psychology Drives Technical Indicators.)

Related Articles
  1. Chart Advisor

    ChartAdvisor for November 27 2015

    Weekly technical summary of the major U.S. indexes.
  2. Professionals

    The Best Financial Modeling Courses for Investment Bankers

    Obtain information, both general and comparative, about the best available financial modeling courses for individuals pursuing a career in investment banking.
  3. Investing

    Where the Price is Right for Dividends

    There are two broad schools of thought for equity income investing: The first pays the highest dividend yields and the second focuses on healthy yields.
  4. Chart Advisor

    Pay Attention To These Stock Patterns Playing Out

    The stocks are all moving different types of patterns. A breakout could signal a major price move in the trending direction, or it could reverse the trend.
  5. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  6. Chart Advisor

    Copper Continues Its Descent

    Copper prices have been under pressure lately and based on these charts it doesn't seem that it will reverse any time soon.
  7. Technical Indicators

    Using Pivot Points For Predictions

    Learn one of the most common methods of finding support and resistance levels.
  8. Chart Advisor

    Watch These Stocks for Breakouts

    These four stocks are moving within price patterns of various size, shape and duration, and are worth watching for a breakout
  9. Chart Advisor

    ChartAdvisor for November 20 2015

    Weekly technical summary of the major U.S. indexes.
  10. Chart Advisor

    Like Ranges? These Are Stocks to Consider

    Whether you want to trade the price fluctuations within a range, or await a breakout, here are four stocks for you.
  1. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  2. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  3. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  4. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  5. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  6. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  2. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  3. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  4. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  5. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  6. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
Trading Center