The Forex Market Trade: The Pitfalls of Indicators

Technical analysis has changed greatly over the past few decades simply due to personal computers making it easy for anyone to enter into a Forex market trade. As little as three decades ago when high powered personal computers were nothing more than science fiction technical analysts shied away from using too many indicators and oscillators simply because they were so difficult to calculate and maintain that it simply wasn’t worth the time. However, computing power has changed all that making the real-time calculation of these indicators simpler than making a cup of tea.

The problem, though, is that new traders tend to go to the other extreme and use too many indicators and oscillators in favor of plain and simple visual chart analysis. They feel that computer generated numbers are much more reliable and can offer clear trading signals when that is not the case. This is simply because indicators and oscillators are calculated according to past data which means that they might provide a little insight into what the market may do but it is no way a definite certainty because these numbers also have to be interpreted.

The Forex Market Trade: Logic vs Psychology

If you compare one Forex market trade to another, even if the conditions were identical and all the indicators showed the same numbers, you will find that one trade might have been profitable and the other was not. Why? Because the market does not move according to a logical, mathematical pattern as much as it does according to market psychology, in other words the psychology of the people who are placing that Forex market trade.

A trader is not a computer, a trader has emotions and even the most experienced traders still sometimes make trades based on emotion. Let’s take an example. Say that the market is in a strong uptrend but you heard some financial analyst say that it is likely to reverse so you enter a short position, even though the indicators and the charts say differently. You enter the trade because you are convinced the analyst is right even if everything else signals he is wrong. When the uptrend continues, rather than exiting your position to minimize loss you stick it out because you are still convinced you are right even though the charts are screaming you are wrong. This is trading on emotion rather than on what the market is showing you.

Now, consider the possibility that more than half the traders in the market heard the same news and decided to take the same trade you did. Then, even if economic data indicates an uptrend and there is no reason for the market to drop, the fact that more traders are taking short positions than long positions will pressure the price into dropping. Of course, this is an oversimplification of what actually happens on the market, but this is essentially how trader psychology moves price, oftentimes completely unrelated to economic data, chart patterns or even indicators.

The Forex Market Trade: Backing Indicators with Visual Analysis

This is not to say that indicators should not be used when you are analyzing a potential Forex market trade but it is a warning that you should limit the number of indicators you are using and back them with visual chart analysis. Some indicators and oscillators can provide buy and sell signals, such as the moving average convergence divergence indicator (MACD), but it is always wise to verify these signals by identifying chart patterns and analyzing exactly what the chart is telling you.

The MACD, for example, is an indicator that is designed to provide buy and sell signals that follow the trend based on points where moving averages cross over. However, since moving averages are an average of past price data this means that the indicator lags slightly behind the market so the signals are not always accurate. This is why you need to ensure that you verify any buy or sell signal with visual analysis before you place your Forex market trade and refrain from relying solely on computer generated indicators.

Related posts:

1. Understanding the Difference between Oscillators and Momentum Indicators
2. FX Trading: Popular Indicators
3. Forex Exchange Rates: Market Psychology and Market Manipulation
4. Scope and Advantages: Forex Technical Analysis
5. Futures Trading: Common Candlestick Patterns
6. Forex Market Trading: An Introduction to Charting
7. The Forex News Trade: Proof that Fundamental Analysis Does Matter