Which Is the Best Indicator for Fx Trading?
You would most likely never have guessed it. It is an indicator that every trader knows and many traders use. The question is whether they use it properly and profitably.
Should you use it? Read on...
The study of 127 indicators
In this book of 800!!! pages the author and his team present
the results of testing the performance of 127 indicators for a period including most of the
previous century for Dow Jones Industrial Average.
(Note: the study doesn’t differentiate between indicators and oscillators.)
Unfortunately a similar study doesn’t exist for the FX market. But indicators are indicators because technical analysis is technical analysis in any market so let’s see whether we can learn from this study something for our FX trading
They compared results of the performance of the Buy&Hold strategy with a strategy using a particular indicator. There were some other rules which are irrelevant for this discussion.
The tested indicators included also the indicators that are widely used in FX trading like:
- various types of moving averages
- Bollinger band
Which of the 127 indicators was the best?
The answer may surprise you because it is nothing fancy and it is something every trader learns very quickly at the start:
The best indicator was the EMA with a period of 5. It
was 78 million percent better than Buy&Hold.
No, this is not a typing mistake. EMA(5) was 780,000 times better. See below a scan from the book.
Even more. All EMAs with periods from 1 to 300 were more profitable than Buy&Hold.
You may be interested in the performance of the popular indicators.
- BB made a loss.
- MACD was on par with Buy&Hold.
- Stochastic was just marginally better than Buy&Hold.
EMA(5) was the star performer. Should you start using EMA(5) from now on in FX trading? Read on.
What if a study like this existed for the Forex market?
Imagine this study was done for the FX market. Imagine indicator X (take your preferred pick!) came out as the best performer.
What would be the answer to the question: Which is the best indicator for FX trading?
Practically everyone who has read the results of the study would respond: “Indicator X!”
But the answer is WRONG!
This is a trap that most traders (who use indicators) fall into and their trading results suffer as a consequence. They believe that the best indicator for their trading is X or a combination of X, Y and Z or whatever.
They believe so because a trading guru told them or they learnt that at a seminar/webinar or they read it in a book or on one of trading forums or whatever. And the sad thing about it is that they take such a claim on more or less face value without having done extensive and exhaustive testing themselves.
Do we know the correct answer to: What is the best indicator for trading FX?
Yes, we know the correct answer. The correct answer is:
NOBODY KNOWS which indicator is the best for FX trading or any trading for that matter.
Now you are going to react: Are you kidding me? Is this what you wanted to tell me? I have been waiting at least for the Holy Grail revelation.
Doesn’t the same expectation about a revelation happen when you see an announcement of this fantastic latest black box indicator which can predict just about everything and is based on neural networks or whatever? You think: “Now this is it. My trading is now going to be profitable.” Until the reality hits after you have spent X dollar on the purchase of this indicator.
If you are prepared to keep an open mind and read the rest you will find out why the correct answer is as presented and your trading may change as a result.
The search for the Holy Grail of trading
Many people search for the Holy Grail of trading despite the fact that they have seen written in many places that it doesn’t exist.
I was one of those people. When I first saw Stochastic I already calculated in how many days (not even years!) I will become a millionaire. This is laughable now but I had to go through some tough times with many indicators to see my mistaken approach.
I am not claiming that the Holy Grail of trading doesn’t exist. Anything is possible in this universe. I just stopped searching for it and changed my trading approach as a result.
Why is it likely that the Holy Grail indicator doesn’t exist? The answer is really simple and can I say logical.
- If there existed an indicator which was the best for FX trading, don’t you think you would have heard about it by now?
- And if you heard about it, wouldn’t other people have heard about it as well?
- Everybody would be using it thus making it a
losing indicator because not everyone can be profitable with trading. It is a
zero sum game, some lose, some win. So a new indicator would be found to be the Holy Grail and the story would repeat itself.
- Testing of any indicator’s performance is done on past data. So the answer about the best indicator can only be: Indicator x WAS the best indicator under these conditions during this period in this market.
- After the time which is defined as NOW nobody knows any more what will happen because we cannot predict the future. Not even clairvoyants know otherwise they would be trading and make zillion doing so. Most clairvoyants are poor.
Additionally, we should not forget the following:
- Indicators are derived from the price, time and
(sometimes) the volume. An indicator is in fact the price action massaged with a
- However, every mathematical calculation strips away a bit of the information presented by the price action itself. If you can read the price action then using an indicator doesn’t add much to the decision making.
What can we conclude about the potential best indicator?
A conclusion is straightforward:
Despite the popular belief and despite a myriad of books written about various winning indicators or indicator combinations and despite all sorts of back testing with supercomputers we CANNOT SAY which indicator IS or WILL BE the best for our trading only which WAS the best.
There will NEVER exist the best indicator for trading in any market. It will only be defined in hindsight because in hindsight we are always right.
Markets change. What worked before may not be working that well now and may not work in the future.
Are indicators useful?
They sure are. Many traders have been and are profitable using various indicators. There are many winning strategies that use indicators. We just don’t know what will happen tomorrow and if the same indicator(s) will still perform well.
Indicators are also useful if one performs auto-trading. Computers are not very good at analysing pictures so filtering a picture into a myriad of numbers is the way to go.
However, once you start arguing whether for example you should use a moving average ribbon with periods of 10, 20, 30, 40 and 50 because they are logical or 8, 13, 21, 34 and 55 because they are natural (Fibonacci!) then you missed the point. Because one ribbon will perform better in some markets under some conditions and the other better in other markets under same or different conditions.
What is the implication of this “revelation” for your trading?
Prosperous trading is a proper combination of many things: indicators (if you choose to use them), strategy, money management, experience, knowledge, discipline, psychology and more, of which some factors are more important than others.
Don’t get forever married to one indicator or to a group of indicators by saying: This works!
The correct way of saying is: This has worked well so far so I am sticking with it hoping(!) that it will continue to work.
And if you get still married to an indicator or a set of indicators at least don’t get married to one set of parameters for those indicators. EMA(5) which has worked well may now need to be replaced with EMA(10) or SMA (13) or the Alligator.
MOST IMPORTANTLY! Once you realise that NOBODY knows which indicator IS and/or WILL BE the best for trading then you stop feeling inadequate when confronting this huge market called FX. As a result, your emotional state becomes more stable when trading.
I wish you prosperous trading with or without indicators.
P.S. If you decide to write a comment I would be interested in hearing your view about what the best indicator is/was. Or send me a message.