Approaches of Technical Analysis Systems

If you take few indicators and combine them so one confirms signals given by other you can say you have an indicators system. How much it is worth? This depends on wide statistical studies done on it which are including testing on historical data (back testing), random data tests, demo market testing and in the end live trading. Most of combinations are failing at some point, especially those which aren't adjusting to current market situation. Good system need to be updated frequently, trader need to change parameters according to changing market. There are few basic rules in making technical indicators systems.

Rule 1 Different approaches
While combining indicators to work together best results give choosing different indicators which are processing market data in much different ways. This makes confirmations more reliable. For example joining few moving averages will give worse results than joining average with RSI oscillator.

Rule 2 Limited number of indicators
There cannot be too many indicators in system. More than 3-4 will make system fogged and difficult to operate. 2-3 is optimal number, at least for me.

Rule 3 Look at big the picture
Many traders and wannabe traders says that you need to follow your system signals blindly. They can't be farther from reasonable approach. You need to take under consideration whole market situation including economic data, formations, trends, supports and resistances and so on. Your system is a tool, not magic wand. If you follow it blindly you will hurt yourself just as carpenter using his saw with closed eyes.

Rule 4
Test before you trade
Huge advantage of technical analysis is that it can be easily tested. Historical testing although it's not very best way to see if system is worthwhile gives wide selection of parameters which provides basic information about the system such as number of transactions made, drawdown, exposure, profit/loss ratio and hit rate. Profit/loss has limited importance as it can be easily adjusted by optimizing parameters of systems indicators. Test system to find where problems are not how good it could be. Try to make it fail - this way you will see how reliable it can be.

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