Many traders who I have worked with over the years ask how much attention should be paid to an indicator.
It’s a great question since many traders, especially newer ones, literally become obsessed with their indicator(s) of choice at the expense of everything else. When the indicator shows buy, they buy. When the indicator shows sell, they sell. And this reaction largely ignores whatever may be happening on the price chart.
Always remember that price action, the direction that the pair is moving, is our primary indicator.
Price is indicator #1…first, last and always.
Therefore, what the informed trader needs to do at the outset is determine the trend – the direction that the market is moving the pair.
Let’s take a look at the historical Daily chart of the CADCHF pair below…
We can clearly see the pair is in a downtrend. Price has been making lower highs and lower lows, it is trading below the 200 SMA (green line) and pulling away from it. This indicates that bearish momentum is gaining strength.
Since this is the case, we know that we only want to look for opportunities to sell the pair.
Now that we have identified the trend, we can make infinitely more effective use of our indicator of choice. In this case our indicator happens to be Slow Stochastics set to 15,5 and 5.
Here’s how we are going to “fine tune” the use of that indicator: we are only going to take selling signals and ignore the signals that tell us to buy the pair.
Each of the signals in the black circles would be the selling signals. And, as you can see, a short position could have been taken successfully on each one.
The buy signals in the red boxes are to be ignored in a downtrend.
Keep in mind that a trader can still have a losing trade even when taking a higher probability entry. However, the likelihood of having a successful trade will be enhanced (not guaranteed) by entering trades in the direction of the trend.
Remember, the indicator has no concept of trend, it only reflects momentum.
As traders, it is up to us to determine the trend and then use our indicator of choice to only take trades in that direction.