How to Overcome Indicator Overload

06/23/2011 4:00 pm EST

Focus: STRATEGIES

Alexander Elder

Author, The New Trading for a Living

Traders tend to focus on finding one or a number of indicators to use in their trading, but Dr. Alexander Elder explains that choosing a proper time frame—not some “magic” indicator—is the most important first step.

There are thousands of indicators to choose from out there when you’re trading, but which ones are the right ones for you, or which ones are the right ones for that particular market environment? 

Our guest today is Dr. Alexander Elder, here to talk about that. So Dr. Elder, what type of indicator should I try? Now you’ve got some, maybe you can talk us through and show us how we can pick one that will work for us.

Well, if you open any good software package, you will get literally hundreds of indicators. I believe TradeStation has 250 of them. Other packages may have more or less. But the point is you don’t need the huge, massive indicators to analyze prices. 

When you look at today’s bar or today’s price action, you have five numbers: Open, high, low, close, and volume. If you do futures, add open interest. You don’t need 20 indicators to analyze five pieces of data. 

I’m a great believer in something called “five bullets to a clip.” An old army rifle took five bullets. Five indicators is enough for a trader. If you’re desperate, you can use six. Seven, you have a problem. 

Now, you’ve got some of your own indicators. Which would you say is the most popular?

I use four indicators: Moving averages, envelopes, MACD (moving average convergence divergence), and the force index, which I invented and described in my book. But to me, the key thing is not the indicators themselves; the key thing is how you layer those indicators in time. 

Markets exist at the same time in multiple time frames. They’re moving on monthly, weekly, daily charts, hourly charts, five-minute charts, and they are very often moving in opposite directions. 

My approach to trading is this: You decide your favorite time frame. Do you like daily charts? Well, if you like daily charts, you’re prohibited from looking at them. You cannot look at those charts until you have gone one order of magnitude up. 

You’ve gone to the weekly chart and made a strategic decision on the weekly. Then and only then can you come back to the daily chart, open it, and now you can use these indictors to decide where you can trade in the direction that weekly chart has given you. 

So, if the weekly has said, “Be a bull,” you’re only looking for buys. If the weekly said, “Be a bear,” you’re only looking for sells.

But that’s really the filtering through time using the bigger time frame for a strategic decision, and your favorite time frame only for the tactical.

Why not trade the direction the market is moving for that day even though the longer-term trend might be up or down? What’s the benefit of that?

Markets don’t move in a straight line. Even if you’re trading for one day, let’s say you’re looking at a five-minute chart. That chart is going to have multiple waves in it, and that’s why I think if you want to trade during the day, go to the 25-minute chart first and decide which way the market is moving today. Then drop down to the five-minute chart and only pick your entry and exit points.

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