Why Indicators Shouldn’t Be Your Primary Trading Tool

09/13/2010 11:50 am EST

Focus: STRATEGIES

Indicators play an important role in the trading methodologies of most traders, professional and retail alike. They do have a part to play in trading success, however, many traders place too great an emphasis on the usage of indicators to give them some kind of "edge" over the market.

Whilst the use of indicators is an important element in most trading methodologies, the overuse of indicators is the nail in the coffin for most newbie traders. Why? Because indicators are liars! They create a false sense of security, making you think that you have an edge over the market; that you know something that others don't.

Trading is much the same. Your MACD might just cross, giving you an entry on a 200-pip long, and many traders will think they have found the Holy grail. Sure, sometimes you might pull off a trade or two, but in the end, there is often pain with systems that are heavily indicator-focused. Why? Because not everyone uses a MACD with your settings, and not everyone uses a Stochastics or an RSI.

I believe to be an effective trader you have to look at what the majority of traders look at. So what do most traders look at? Support and resistance! Almost every system out there uses support and resistance to some extent. Support and resistance is our number-one indicator.

Using a system focused around support and resistance offers many benefits, Firstly, you take trades in areas where the market has previously reacted, and you take advantage of emotion-based "market memory." Secondly, you limit the number of trades you take to areas in which you "want to do business." Overtrading can really drain your account, and limiting trades to areas where the odds are more in your favor adds to your edge. Thirdly, focusing on support and resistance greatly simplifies your approach to trading. Price-based support and resistance (swing lows, day highs, day lows) with volume-based confirmation (volume profile) seem to offer the best odds.

In many instances, historically referenced support and resistance levels can help traders catch market tops/bottoms to the very tick! Everyone from hedge funds and banks to the smalltime trader at home uses support and resistance levels. Thus for lasting success in the market, it is important to utilize this very simple, but often overlooked technique.

Now where do indicators fit into all this? Indicators can add immense value if used appropriately. The following analogy may help in gaining some perspective. You're about to go out to a dinner party and are getting dressed. Now the core of your outfit will be your suit, shirt, socks, underwear, and shoes. These core elements are what make up your attire for the evening and are all pretty important for you to wear because these are the things people will look at most. As an accessory, you happen to wear some cuff links, just to complete the look.

I believe that support and resistance should be the core of a trading methodology, as these are the things people will look at most. Indicators should be the accessories just to complete the look.

Now you wouldn't go to a dinner party just wearing cuff links, would you?

By Aamar Shehzad, chief technical analyst and managing director, PivotFarm.com

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