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…when to rely on indicators

Hi friend,

I just relocated to Thailand for the next two months, looking forward to running my routine from a tropical setting again, I have been missing that.

While on the flight from Copenhagen, I was going through questions I got from the Learn to Invest Confidently in 30 Days course and one that stood out was about indicators.

For experienced investors, the myriad of indicators is not a jungle and sometimes for beginners it causes confusion.

Let’s look into what indicators actually are and how to use them.

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An indicator is simply a fact about an asset represented by data.

We use indicators to decide how we want to execute a trade or investment.

Every strategy relies on indicators, it is just that when you are starting out you might not be thinking about it.

The simplest indicator is the price of an asset.

As you can imagine this is not a particularly good indicator because it does not tell us anything that allows us to make educated guesses about how the asset will perform in the future.

Beginners will typically look at the price and decide if it is too high or too low. This is not founded on any proper analysis so it is just pure guessing. We want to make predictions which are guesses backed by information that affects the price performance.

This is the first lesson. Indicators are simply data. It is how you use it that matters.

Keep this in mind next time you stumble on someone peddling trading systems based on complex indicators.

Because indicators are just data, we can take any data points about the asset we can get our hands on, and combine them.

We then observe how the indicators perform over time and try to identify repeating patterns we can execute on.

A widely used indicator example is the 200 simple moving average, typically used daily.

This indicator consists of taking the closing price of the last 200 days for an asset and computing the average. Calculating this daily you can plot a line chart and superimpose it on the price chart for the asset. If the price is above the average we are in a bullish scenario and if the price is below we are in a bearish scenario.

A naive use of this indicator would be to buy when below and sell when above.

Try it out on some charts roleplaying your entries and exits and you will see that it is not as easy as it sounds.

Because of this, typically we either would add other indicators or fundamental analysis to try to build a strategy that would work for us with some consistency.

This is where a lot of confusion arises.

It is easy to take simple indicators and build trading bots based on them.

It is easy to form complex indicators, backtest their performance, and sell a system based on the performing ones.

The problem is that you rarely know the full story.

Always pay more attention to the execution rules and the consistency of any system.

Consistency is a ratio of how many of the trades in a single portfolio following a single strategy result in gains vs losses.

An indicator-based trading system will likely stop working the second you change the asset for a similar one or the trading time window.

This is why I focus on teaching self-control and execution more than providing systems for beginners. I want you to be able to come up with strategies based on your personal edge. In a second phase, you will then try to identify the indicators behind your strategy and make it a system, maybe then even a bot.

Lastly for this time about indicators, so many focus on entry indicators. It is just as important to have exit indicators and no one says that the same indicator that shows you when to enter should also show you when to exit.

This is why I love investing, there are infinite possibilities if you are just curious, creative, and disciplined.

What indicators do you use? Are there any in particular you would like me to write about?

Have fun and make profits,

Chris

Thank you for reading! :)

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DISCLAIMER: None of this is financial advice. This letter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.