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Nick Goold

There are so many different trading indicators available it's almost impossible to keep count. With new ones created every day, often highly technical with convincing data, novice traders may be confused and have trouble deciding which one to use. Often they try a variety of indicators, but if they don't get good results straight away, they flip to one after another, usually with little success, and lose hope of finding a good one they can rely on.

It's well known that professional traders tend to use only one or two indicators, becoming more and more comfortable with them over time and accumulating years of experience using their preferred ones. They've learned to adapt their indicator's use over time, rather than switching indicators every few months or so, which is not enough time to develop a good understanding of the indicator and how to use it effectively to make consistent profits.

While indicators can be a powerful trading tool, it's critical to understand not just how to use them, but also when to use them - and particularly when not to use them. For this reason, understanding the strengths and weaknesses of each candidate indicator is very important.

Trading indicators - 5 things you need to understand

  • Is the indicator suitable for trending or ranging markets?
  • Is the indicator suitable for quiet or volatile markets?
  • Is the indicator suitable for short-term or long-term trading?
  • How often does the indicator generate trading signals?
  • How should you use the indicator to find good profit-taking and stop-loss levels?

Understanding and identifying these five points will put you in a great position to begin testing each indicator's performance.

Now let's look at some steps to finding the best indicator to use:

Step 1: Test different indicators with paper trading at first, recording and comparing results

It's also important to test each indicator in the actual market you plan to trade and understand how it functions. It's best to use a demo account to start with, as this lets you practice over and over, without fear of loss. When you do begin dealing in a real money account, use the minimum trading size and practice trading while keeping losses as low as possible. As you repeat and practice, record the results to see which indicators are the most profitable.

Step 2: Select indicators that are easy to understand and use

Once you've found the indicator with the best performance, focus on using that one. If you've been practising on a demo account, start trading on a real account with a small amount. After you've built up a stable run of profits, start to increase your position size. When a trade has been closed out, make sure to note the entry and exit points on the chart and check you used the indicator signs correctly, or if there were better entry and exit points which you could have used with that indicator.

Step 3: Specialise in that indicator

Now you've decided on an indicator to use, you can develop your knowledge of that indicator. By using the same one over time, you will better understand its strengths and weaknesses. Remember, the better you understand the indicator, the more you will be able to adapt it to changing market conditions based on your experience of using it in the past.

Don't expect immediate results. Keep a long-term perspective and wait for clear signals. Don't rush to trade or try to anticipate a signal.

If you keep to these steps, your indicator should help you to grow your capital steadily over time.