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Should You Stack Indicators?

Should You Stack Indicators?

2012-09-28 03:00:00
Tyler Yell, Trading Instructor,,

An overly congested chart does more harm than good. Indicators have their place and I would not place a lot of trades without consulting my favorites. However, when price action is lost among the indicators it’s time to do a clean-up and get back to the best indicator of all, price action. By the end of this article, you will walk away with a checklist to know whether your indicators are doing more harm than good and two examples of simple and clean strategies.

Indicators translate the meaning behind price action so that you’re not confused and can see the big picture. Traveling without a translator is similar to how traders often feel without their indicators. We’re not here to take them away but organize and minimize what you use so that you’re not only effective in your analysis but, efficient as well.

Trading Rule: Less is more. Don’t suffocate price action with an indicator jam.

Should You Stack Indicators?

(Created by T. Yell)

Too many indicators turn to the trading equivalent of a horrific traffic jam circling around price action.

Should You Stack Indicators?

We can and should appreciate the hard work that indicators do for us. Naturally, indicators should be the simplest way for you to read price action and trade accordingly.

Here is 3-part my litmus test for whether an indicator should be on my chart:

  • Does this indicator simplify the overall trend for me or whether one exists? Or does it help me identify high probability trades?
  • Do I have a clear entry and exit based on what the indicator is telling me about price action? Or does this help me manage my risk and stick to my plan?
  • Is this the only indicator performing this function? (example: Relative Strength & Slow Stochastic) Or am I duplicating efforts and causing too much confusion?

Should you answer “no” to any question, dump the indicator. If the indicator is not helping you understand which way the market is moving and the understanding how easily the market is moving in that direction , it’s of little value to you or there is no trade set up worth your time.

A client once shared with me that trading price action alone was as confusing as trading the next breeze coming through town. There was no rhyme or reason to what the chart was telling him without an indicator. When he threw on two moving averages and the Heiken-Ashi indictor though, he had everything he needed. He found his happy place on the charts.

I challenge you to find yours. You will know you’re there when one less indicator would severely obstruct your plan and one more would be unnecessary.

Here are some commonly used indicators that are properly stacked to give you an idea of stacking without too much noise on top of price action:

Example 1:

Base Indicator to identify trending environment: ADX (14)

Top Indicator to identify entry and exit: Parabolic SAR

Chart:

Should You Stack Indicators?

(Created by T. Yell)

Example 2:

Base Indicator to identify trending environment: Exponential Moving Average (100)

Top Indicator to identify entry and exit: Donchian Channel (55) for Breakout Entries.

Chart:

Should You Stack Indicators?

(Created by T. Yell)

  • (#) = number of periods the indicator is analyzing

I’ve talked to traders through the years who have had success with simple strategies. Obviously, they focused first on a system that meshed with their personality and then built a trading plan around that.

I advocate being smart about entries but there is no such thing as a riskless trade. Indicators help but adding more doesn’t take away the risk. Stick with the number of indicators that give you an edge and only trade with strong risk: reward ratios.

---Written by Tyler Yell, Trading Instructor

To contact Tyler, email tyell@DailyFX.com.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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