Are you trying to develop a trading strategy with the use of technical indicators? There’s always been some misunderstanding between a trading strategy and the technical indicators. Most people take these two as one or the same thing.
It’s been noted that new traders mostly make this mistake of taking technical tools as a strategy. Whereas, it should be clear from the beginning of the financial journey of an investor that technical analysis tools should be taken as indicators only instead of fully operational trading strategy as a whole.
In other words, a technical indicator is a medium to get insights on past trends and to anticipate the future movement of financial instruments, commodities, securities, etc.
Difference Between Technical Indicator & A Trading Strategy
An indicator can help a trader in forecasting conditions of the market, whereas a strategy is a trader’s rulebook: Including interpretation and applying various technical indicators to make better-educated guesses about the future movement of the market.
Different categories of technical trading tools consist of the trend, volume, volatility characteristics, and momentum technical indicators. Traders are also advised to use different categories or types of technical indicators to develop a strategy.
Few Things to Consider While Developing a Trading Strategy?
Different sorts of technical indicators are usually recommended when using more than one indicator in a trading strategy. However, the use of different indicators but of the same types results in multicollinearity (i.e., a state when the same information is calculated multiple times). It needs to be avoided as it results in providing an inaccurate picture and also results in overcoming the value of other indicators hence less useful.
Therefore, traders should pick indicators from different categories such as one trend indicator and one momentum indicator. With one more indicator that should be used for confirmation ( for ensuring other indicators are picturing an accurate result).
Each indicator and its combination with another requires a keen knowledge of each indicator and its application to the trader’s style and risk tolerance. One merit of developing a strategy like this is to provide them the option of applying this strategy to the past data to evaluate the success rate of the strategy. This process is also known as backtesting. Of course, this does not result in guaranteed results only but it might help you in reducing risk.
NOTE: Just to avoid any obscurity – An indicator is not a strategy but a mean which can be employed while crafting a trading strategy.