Development of Trading Strategies by means of Technical Indicators
Posted by Boris F at 1/25/2012 1:35 AM 
Categories: forex strategies, metatrader indicators, forex trading strategies, expert advisor, Forex Indicators, metatrader expert advisor, expert advisors, forex divergence, metatrader expert advisors, metatrader indicator
Categories: forex strategies, metatrader indicators, forex trading strategies, expert advisor, Forex Indicators, metatrader expert advisor, expert advisors, forex divergence, metatrader expert advisors, metatrader indicator
Traders and investors use different indicators for analyzing events of the past and forecasting future patterns and price trends. These indicators represent mathematically-based tools for technical analysis and include the Bollinger Bands indicator, moving averages and so on. While fundamentalists rely on different economic and annual reports, traders, who prefer using technical analysis, give preference to indicators, which help them to make interpretation of the market. The main advantage and purpose of indicators is ability to identify trading opportunities. For instance, a trend change may well be preceded by a moving average crossover. In this case, if a trader wants to find possible areas of trend change on a price chart, he should apply the moving average indicator to this chart.
On the other hand, indicators are used in different strategies quite often, because they allow to determine entry, exit and trade management rules objectively and impartially. When we say “strategies”, we mean a definitive set of rules, which regulate the process of trade and specify the exact establishment, management and closure of trades. As a rule, one and even several indicators are used in strategies in detail in order to establish instances where trading activity will occur.
No concrete trading strategies will be reviewed in the given article, but we will try to explain the difference between indicators and strategies, and also say some words about principles of their combined work, which allow technical analysts to determine very probable trading setups.
Traders can study and analyze many different technical indicators. There are commercially available proprietary indicators as well as those in the public domain, for example, stochastic oscillator or a moving average. Moreover, some traders often resort to services of professional programmers to develop their own custom indicators or do it manually on their own. The majority of indicators are provided with user-defined variables that are used by traders in order to adapt key inputs in accordance with their needs.
For instance, a moving average is just an average price of securities over a definite period of time. This period of time is stated in the type of MA (for example, a 50-day MA). The number “50” means that the given MA will show you the average price for a 50-day time period. As a rule, closing price of securities is used in calculation of MA, but it doesn’t mean that other price points can’t be used for this purpose (for instance, open, high or low). The trader can specify the price point for making calculations an also the length of the MA.
Let’s define a trading strategy once again. It is a set of rules, which regulate the process of trade and define order and time of trader’s actions. As a rule, filters and triggers are based on indicators and included as compounds of a strategy. The aim of filters consists in identifying the setup conditions, and the aim of triggers consists in timing, i.e. they “decide” when some action should be done.
Here is an example of a trade filter: a price that has closed above its 200-day MA. This prepares the ground for the trade trigger, i.e. for some event that causes trader’s actions. It is also known as “the line in the sand”. For example, when price reaches one tick above the bar that breached the 200-day MA, it well may be a condition for a trade trigger.
It should be noted that it is wrong thinking about a trading strategy as about a simple instrument, which buys when price reaches a position above the MA. A strategy is a very evasive tool and it can’t provide any specified details, which help to take some actions. Here are several items, which should be followed in order to create an objective strategy:
1. You should know what kind of MA you are going to use. You should also know length and price point, which will be included into calculation.
2. It is necessary to define a point above the MA, above which price needs to move.
3. You should choose the moment, when the trade should be entered. There are three options: when price reaches the specified point above the MA, when the bar is closed or when the next bar is opened.
4. You should also choose the type of order (market, limit), which you are going to use in order to place a trade.
5. Of course, the amount of shares of contracts to be traded should be specified.
6. Make decision about the rules of money management.
7. Finally, define the exit rules.
An objective strategy can be formed only on the basis of the abovementioned preconditions.
An indicator itself can’t be considered as a strategy. It only plays a role of a tool, used by traders to identify market conditions. On the other hand, a strategy is a set of rules, defined by a trader, which specify application and interpretation of indicators for the purpose of making correct predictions of future market activity. Volume, trend, momentum and volatility – these are among different categories of indicators. As a rule, several different types of indicators are used by traders in their strategies. If a trader uses multiple indicators of the same type, so-called “multicollinearity” or multiple counting of the same information may occur. Such situation is not advisable because multicollinearity may influence other variables and underestimate their importance because of redundant results of multicollinearity. Therefore, it is much better to apply indicators from different categories in a strategy: for example, a trader can use trend and momentum indicators. It often happens that traders use some indicator for making confirmation of signal accuracy of another indicator.
For instance, a momentum indicator can be used to confirm the validity of the trading signal of a MA strategy. Relative Strength Index or RSI is a momentum indicator. It compares the average price change of advancing and declining periods. There are user-defined variable inputs in RSI as well as in other technical indicators, so a trader can define, for example, overbought and oversold levels. It means that a trader can use RSI for confirmation of any MA signals. If there are opposing signals, it might point to a lesser reliability of signal and probable insecurity of the trade.
Of course, a trader must do researches of the chosen indicator (or several indicators) in order to find the most appropriate application of this indicator. Trader’s style and readiness to risk should be also taken into account. The use of a strategy has one major advantage: it allows to perform backtesting, i.e. to use historical data in order to check if the given strategy would be successful in the past. Of course, there are no guarantees that the given strategy will be successful in future, but still it is a very helpful tool for development of a profitable trading strategy.
No matter what kind of indicators you are going to use, you must clearly specify interpretation of indicators and their precise actions in your trading strategy. Indicators are just tools and do not produce any trading signals on their own, so you should include them in a strategy and be as precise as possible, because ambiguity is very dangerous.
Before choosing indicators a trader should decide what type of strategy he is going to create, because it influences the choice. And again, trader’s style and readiness to risk should be taken into account. If a trader is intended to focus on long-term moves and large profits, he might use a trend-following MA indicator and create a trend-following strategy; in case a trader is intended to focus on small moves and frequent small profits, he might try to create a strategy based on volatility. A trader can also use various additional indicators in order to confirm received signals.
Of course, there is another way: a trader can simply buy a so-called “black box” trading strategy or a commercially available proprietary strategy. There are advantages and disadvantages of using this type of strategies. The advantage is that all the necessary researches and backtests have already been done in advance (theoretically), and a trader shouldn’t do anything else on his own. On the other hand, there is a major disadvantage: a trader completely trusts developers of this strategy and often can’t make any customizations in accordance with his own style of trading
Trading signals are not produces solely by indicators. The ways of sending signals by indicators should be developed by a trader. A trader is also responsible for creation of trading strategies. Of course, it is possible to use indicators without being used in combination within a single strategy, but at least one type of indicator is necessary for creation of technical trading strategies. Creation of a strategy, which represents a set of rules, which regulate the process of trade and define order and time of trader’s actions, allows a trader to perform backtests in order to find out if his trading strategy would be viable. It also allows a trader to draw conclusions about behavior of a strategy in future. It is very important to technical traders, because it allows them to make constant evaluation of the strategy performance. Moreover, it allows traders to make decisions concerning time of closure of a position.
There are talks among traders about some king of “Holy Grail”, which would allow them to make profit instantly. Unfortunately, there is no perfection in our world, and there is no possibility to develop an ideal strategy that will bring guaranteed profit to all traders. There are many traders, and each has his own style, readiness to risk, temperament and personality. It means that everyone decides by himself what technical analysis tools he is going to use. Traders also have to make researches personally and develop strategies on their own, basing on the results of these researches.
http://iticsoftware.com
On the other hand, indicators are used in different strategies quite often, because they allow to determine entry, exit and trade management rules objectively and impartially. When we say “strategies”, we mean a definitive set of rules, which regulate the process of trade and specify the exact establishment, management and closure of trades. As a rule, one and even several indicators are used in strategies in detail in order to establish instances where trading activity will occur.
No concrete trading strategies will be reviewed in the given article, but we will try to explain the difference between indicators and strategies, and also say some words about principles of their combined work, which allow technical analysts to determine very probable trading setups.
Forex Indicators
Traders can study and analyze many different technical indicators. There are commercially available proprietary indicators as well as those in the public domain, for example, stochastic oscillator or a moving average. Moreover, some traders often resort to services of professional programmers to develop their own custom indicators or do it manually on their own. The majority of indicators are provided with user-defined variables that are used by traders in order to adapt key inputs in accordance with their needs.
For instance, a moving average is just an average price of securities over a definite period of time. This period of time is stated in the type of MA (for example, a 50-day MA). The number “50” means that the given MA will show you the average price for a 50-day time period. As a rule, closing price of securities is used in calculation of MA, but it doesn’t mean that other price points can’t be used for this purpose (for instance, open, high or low). The trader can specify the price point for making calculations an also the length of the MA.
Trading Strategies
Let’s define a trading strategy once again. It is a set of rules, which regulate the process of trade and define order and time of trader’s actions. As a rule, filters and triggers are based on indicators and included as compounds of a strategy. The aim of filters consists in identifying the setup conditions, and the aim of triggers consists in timing, i.e. they “decide” when some action should be done.
Here is an example of a trade filter: a price that has closed above its 200-day MA. This prepares the ground for the trade trigger, i.e. for some event that causes trader’s actions. It is also known as “the line in the sand”. For example, when price reaches one tick above the bar that breached the 200-day MA, it well may be a condition for a trade trigger.
It should be noted that it is wrong thinking about a trading strategy as about a simple instrument, which buys when price reaches a position above the MA. A strategy is a very evasive tool and it can’t provide any specified details, which help to take some actions. Here are several items, which should be followed in order to create an objective strategy:
1. You should know what kind of MA you are going to use. You should also know length and price point, which will be included into calculation.
2. It is necessary to define a point above the MA, above which price needs to move.
3. You should choose the moment, when the trade should be entered. There are three options: when price reaches the specified point above the MA, when the bar is closed or when the next bar is opened.
4. You should also choose the type of order (market, limit), which you are going to use in order to place a trade.
5. Of course, the amount of shares of contracts to be traded should be specified.
6. Make decision about the rules of money management.
7. Finally, define the exit rules.
An objective strategy can be formed only on the basis of the abovementioned preconditions.
Development of Strategies by means of Technical Indicators
An indicator itself can’t be considered as a strategy. It only plays a role of a tool, used by traders to identify market conditions. On the other hand, a strategy is a set of rules, defined by a trader, which specify application and interpretation of indicators for the purpose of making correct predictions of future market activity. Volume, trend, momentum and volatility – these are among different categories of indicators. As a rule, several different types of indicators are used by traders in their strategies. If a trader uses multiple indicators of the same type, so-called “multicollinearity” or multiple counting of the same information may occur. Such situation is not advisable because multicollinearity may influence other variables and underestimate their importance because of redundant results of multicollinearity. Therefore, it is much better to apply indicators from different categories in a strategy: for example, a trader can use trend and momentum indicators. It often happens that traders use some indicator for making confirmation of signal accuracy of another indicator.
For instance, a momentum indicator can be used to confirm the validity of the trading signal of a MA strategy. Relative Strength Index or RSI is a momentum indicator. It compares the average price change of advancing and declining periods. There are user-defined variable inputs in RSI as well as in other technical indicators, so a trader can define, for example, overbought and oversold levels. It means that a trader can use RSI for confirmation of any MA signals. If there are opposing signals, it might point to a lesser reliability of signal and probable insecurity of the trade.
Of course, a trader must do researches of the chosen indicator (or several indicators) in order to find the most appropriate application of this indicator. Trader’s style and readiness to risk should be also taken into account. The use of a strategy has one major advantage: it allows to perform backtesting, i.e. to use historical data in order to check if the given strategy would be successful in the past. Of course, there are no guarantees that the given strategy will be successful in future, but still it is a very helpful tool for development of a profitable trading strategy.
No matter what kind of indicators you are going to use, you must clearly specify interpretation of indicators and their precise actions in your trading strategy. Indicators are just tools and do not produce any trading signals on their own, so you should include them in a strategy and be as precise as possible, because ambiguity is very dangerous.
Picking out Indicators for a Strategy
Before choosing indicators a trader should decide what type of strategy he is going to create, because it influences the choice. And again, trader’s style and readiness to risk should be taken into account. If a trader is intended to focus on long-term moves and large profits, he might use a trend-following MA indicator and create a trend-following strategy; in case a trader is intended to focus on small moves and frequent small profits, he might try to create a strategy based on volatility. A trader can also use various additional indicators in order to confirm received signals.
Of course, there is another way: a trader can simply buy a so-called “black box” trading strategy or a commercially available proprietary strategy. There are advantages and disadvantages of using this type of strategies. The advantage is that all the necessary researches and backtests have already been done in advance (theoretically), and a trader shouldn’t do anything else on his own. On the other hand, there is a major disadvantage: a trader completely trusts developers of this strategy and often can’t make any customizations in accordance with his own style of trading
Conclusion
Trading signals are not produces solely by indicators. The ways of sending signals by indicators should be developed by a trader. A trader is also responsible for creation of trading strategies. Of course, it is possible to use indicators without being used in combination within a single strategy, but at least one type of indicator is necessary for creation of technical trading strategies. Creation of a strategy, which represents a set of rules, which regulate the process of trade and define order and time of trader’s actions, allows a trader to perform backtests in order to find out if his trading strategy would be viable. It also allows a trader to draw conclusions about behavior of a strategy in future. It is very important to technical traders, because it allows them to make constant evaluation of the strategy performance. Moreover, it allows traders to make decisions concerning time of closure of a position.
There are talks among traders about some king of “Holy Grail”, which would allow them to make profit instantly. Unfortunately, there is no perfection in our world, and there is no possibility to develop an ideal strategy that will bring guaranteed profit to all traders. There are many traders, and each has his own style, readiness to risk, temperament and personality. It means that everyone decides by himself what technical analysis tools he is going to use. Traders also have to make researches personally and develop strategies on their own, basing on the results of these researches.
http://iticsoftware.com
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