Knowing what indicators are, how to use them, and what is the best combination of technical indicators can dramatically improve your chart reading skills. If you use a technical indicator incorrectly, it can lead to inaccurate price interpretation and, subsequently, to bad trading decisions.
Technical indicators make it easy for you to identify current price trends and predict where prices will move in the future. By developing effective technical analysis strategies, you can increase the amount you earn each trading day.
However, while all technical indicators are useful, they do have their own set of weaknesses. If you only use a single indicator to monitor the market, there may be certain price trends (or hazards) that you aren't noticing.
By combining multiple technical indicators into a single trading strategy, you can potentially limit your risks and predict trends more accurately.
In this article, we will be discussing the best practices on how to create a multi-indicator strategy. A multi-indicator strategy should avoid being redundant and should use the best combination of trading indicators in a meaningful way.
For novice traders, a multi-indicator strategy carries the risk of delivering redundant outputs because many times traders use indicators that show the same type of information. To avoid being trapped by such trading misconceptions, you need to understand that technical indicators can be classified into three groups:
Types of Technical Indicators
Trend Following Indicators
These indicators allow you to determine whether an asset is currently overbought or oversold. Many trend following indicators, such as Bollinger Bands, attempt to create a clear ‘channel’. A clear channel will tell you whether prices are close to breaking out or returning to normal.
Momentum Indicators
Momentum indicators such as the Relative Strength Index (RSI) allow you to determine the direction and strength of a current price trend. RSI measures if the current price is oversold or overbought. As an asset begins to build momentum, opening a new position will become less risky. Looking at moving average indicators also helps you gauge momentum.
Volatility Indicators
These show how much the price of the asset is changing in a set period. The price has to be volatile in order for a trader to be able to trade it, but high volatility is also associated with higher risk.
Now that you understand the different types of indicators, let's understand how to combine the various technical indicators to come up with a winning trading strategy. In fact, using the various indicators, you can build popular combinations that you can use to build advanced strategies on uTrade Algos.
Different Trade Strategies
MACD Combinations
It can be used together with other trading indicators to identify trading opportunities.
It is commonly combined with RSI, Stochastic, supports, and resistances.
Let’s give examples of how you can combine the MACD with other trading indicators.
MACD + Stochastic RSI
The stochastic RSI indicator helps traders determine when a security is overbought as well as when it is oversold. We have already discussed these indicators in detail, you can check our previous blogs for their detailed description.
The MACD is a trend following indicator that helps traders know the relationship between 26 and 12 days EMA that are used to calculate the MACD and the signal lines.
The stochastic RSI indicator oscillates between 0 and 100, with positions below 100 being considered oversold and positions above 80 being considered overbought.
The MACD indicator, on the other hand, gives traders buy and sell signals through crossovers between its MACD line and the signal line.
When the MACD line goes above the signal line, the indicator sends a buy signal.
When the MACD line goes below the signal line, it gives a sell signal.
Here is how you can combine these two indicators:
MACD gives a buy or sell signal through a crossover of its MACD and signal lines.
Stochastic levels rise above 80 (overbought, sell signal) or below 20 (oversold, buy signal).
The two indicators give the same type of signal (buy or sell).
Consider the chart given below:
The above chart shows how you can use the MACD and stochastic RSI indicators to run a trade.
You should sell the trade at the position marked as ‘Sell’ on the chart.
But, what is happening with the indicators at that time?
This has been shown using two bold blue circles on the indicators section of the chart.
During that time, the MACD lines make a bearish crossover, that is, the MACD line begins to move below the Signal line.
The Stochastic RSI indicator was at an overbought position (above 80) at that point.
A combination of these two indicator signals sends a sell signal.
So, it’s possible for a trader to combine the stochastic and the MACD indicators to run a successful trade.
MACD + RSI
The RSI technical indicator is a momentum indicator that measures the recent price changes so as to determine if the current price is oversold or overbought.
It oscillates within a range of 0 and 100 and sets the overbought and oversold positions.
The RSI overbought level is set at 70, while the RSI oversold position is set at 30.
So, all RSI positions above 70 are considered overbought and all positions below 30 are considered oversold.
They work similarly as the previous case:
MACD sends a buy or sell signal after a crossover of both of its lines, the MACD and signal lines.
All RSI levels move above 70 (overbought) or below 30 (oversold).
The two indicators give the same type of signal.
Consider the chart given below
The above graph shows the RSI and the MACD indicators added to a single chart.
You should enter a sell trade at the position marked as ‘Sell’ on the chart.
If you look at the RSI indicator, it is above 70. This means that it’s in an overbought position.
This has been shown by the bold black circles on the indicator.
At the same time, the MACD indicator makes a bearish crossover.
The MACD line of the indicator crosses the signal line and begins to move below it.
This generates a sell signal. This is a good time for you to sell the security.
The price action entered a bearish move from that time, and this bearish move continued for some time.
MACD + DMI
The DMI indicator is used to measure the strength of positive and negative trends.
The indicator sends sell and buy signals after a crossover happens between the +DI and the –DI lines.
When the +DI crosses the –DI in an upwards direction, it’s an indication that the price of the forex pair is increasing. This generates a buy signal, meaning that it’s a good opportunity for you to enter a long position.
When the +DI crosses the –DI in a downwards direction, it’s an indication that the price of the forex pair is decreasing. Hence, it’s a good opportunity for you to enter a short position.
You can combine the DMI and the MACD indicators to come up with a trading strategy that works as follows:
MACD generates a buy or sell signal after a crossover of both of its lines, that is, the MACD and the signal lines.
DMI generates a buy or sell signal after a DMI crossover.
The signals are generated at the same time or at the time of the ‘Keep signal for x candles’.
Consider the chart given below:
The above graph shows the DMI and MACD indicators added to a chart.
You should buy the security at the position marked as ‘Buy’ on the chart.
During this time, the +DI line of the DMI indicator crosses the –DI line of the same indicator in a bearish direction.
This is an indication that the price of the security is decreasing, hence, it’s a good time for you to enter a short position.
The MACD indicator also gives a similar signal.
RSI Combinations
RSI + OBV
The RSI (Relative Strength Index) is a momentum and leading indicator at the same time. It is loved by most traders because it is easy to use. The RSI technical indicator shows the possible overbought and oversold positions in the market.
The OBV (On-Balance Volume) indicator, on the other hand, works based on the idea that both the volume and the price activity are equally important. It combines both the price and the volume so as to show you the total amount of funds that go in and out of the market.
These two indicators can be combined to come up with a great trading strategy.
Consider the chart given below:
- The above graph shows the RSI and OBV indicators combined in a single chart.
- You should enter a short position at the point marked as ‘Sell’ on the chart
- The RSI indicator is above 70 at this point, which is a signal that the forex pair is overbought.
- At the same time, the OBV indicator begins to make a bearish move.
- This has been shown by the two bold black circles on the chart.
- These two signals are an indication that the price action is about to begin a bearish move, meaning that it is time for you to enter a short position.
- The price began to make a bearish move from that position.
- This is also the same trend shown by both indicators.
- At this point, the RSI indicator is below 30, which is a signal that the security is oversold.
- At the same time, the OBV indicator is beginning to move upwards, which is an indication that a bullish trend is beginning in the market.
- At this point, you should exit your short position and enter a long position.
This way, you will benefit from the bullish move that results from the price action.
RSI + Bollinger Bands
Bollinger Bands shows the periods of high and low volatility of the asset. The more wide apart the bands are, the higher the volatility and the stronger the movement is.
With these two indicators combined, a buy signal is received when candlesticks cross the bottom line of BB and the RSI line crosses the oversold level and starts moving up. A sell signal is received when the chart crosses the upper band and the RSI is in the overbought level, starting to reverse down.
SMA + Stochastic RSI
As we have already discussed Stochastics RSI above and SMA is a simple moving average, it can be said that this is a basic tool which helps a trader see the real picture of the market direction.
Using these two indicators together, the following signals might be indicated. When the market breaks the SMA line from below upwards and the blue line of the stochastic RSI crosses the red line upwards, it may be a sign of an upward trend. A signal of a downward trend is received when the market crosses the SMA line from above downwards and the stochastic RSI shows the blue line crossing the red line downwards.
ATR + Parabolic SAR
ATR is a volatility indicator, measuring how volatile the market is.
Combining ATR with parabolic SAR (a trend indicator) may help the trader find entry points during a trending market while setting potentially more accurate ‘Take Profit and Stop Loss’ levels.
While combining these indicators, one may watch for the signals given out by parabolic SAR.
A buy signal is received when the dotted line is below the price chart.
A sell signal is received when the dotted line is above it.
A possible entry point is marked when the parabolic moves from one position to another (for instance, it changes from being above the candle chart to moving below it).
We demonstrated how to combine and take meaningful answers from technical tools which in turn help us determine trends, future directions, entries and exits and other necessary market data.
Is everything that easy OR Are we living in a perfect world?
Of course not!
The first problem is that alerts coming from the market are sometimes wrong. Also, more is not always better, but be careful to also avoid indicator redundancy and pick combinations that show complimentary information to make a stronger entry or exit in your trading strategies.
HAPPY TRADING!
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