The set of tools should not be excessive, because you have to analyze them within different time frames, from an hour to a week. Besides, even three or four indicators can give you controversial signals.
As soon as you choose one or two automated technical indicators, you need to test them. Backtesting is usually carried out in two stages. First, you test them on available. Second, you repeat the procedure in life trading. Backtesting helps to discover the pitfalls rarely mentioned in manuals. You learn how to recognize signals of an indicator. In retrospective, everything seems so clear and simple, but the online trading requires certain skills. Eventually, you will understand that books do not always describe the actual signals, and you will make your own list of signals.
To begin with, you need to find out whether a chosen indicator suits you.
You just have to calculate a number of correct signals based on the available data. If you are satisfied with the results, the next step is to optimize those indicators. In other words, you have to get the highest possible number of correct signals. The most popular method of optimization is to substitute the variables used to calculate the indicator. Mathematical optimization (formulas) is possible, but it is more suitable for those who are very good at mathematics or understand the market perfectly well. Meanwhile, it is not necessary that you use the same values for different time frames. For example, the 10-day moving average on a daily chart is very likely to give correct signals. At the same time, the best period of the moving average for the intraday trading is 5 or 7 days. The most important thing is to identify when the indicator gives the highest number of correct signals. That is the major objective of optimization.
The second stage of the backtesting is carried out with the use of the optimized indicators. By this point, indicators must give correct signals online, and you have to be able to spot them. In real time, the number of correct signals may be different, so you might need to optimize them once again.
Next, you combine signals, indicators and methods of classic technical analysis into an overall signal that determines entry and exit points in the market.
For example, the following development can signal an entry point to go short:
The market is in an uptrend, and the latest price movements formed the Engulfing pattern. When the reversal pattern was formed, MACD does not reach a new high. It means the price divergence is possible, and the further decline confirms that. The breach of the uptrend line once again confirms previous signals of the probable trend reversal. When the stochastic oscillator falls beyond the overbought level, and some downside movement occurs, the signal to open short positions is complete.
Trading systems are rarely optimized up to 90 percent of successful signals. Do not wear yourself out trying to achieve impossible things. The ratio of 70/30 can be considered enough to trade successfully on Forex.
Now try to develop your own trading system. When you create a trading system, you should follow a logical concept based on theoretical knowledge and observations.
While you are still a novice in the market, you’d better stick to a simple rule of trend trading. That is why you have to design a trading system with the use of trend-following indicators. First, you choose the financial instrument you are going to trade. Then you decide on a time frame depending on what kind of trading you prefer. In case of the intraday trading you should pick a short period from five to thirty minutes. If you prefer a longer-term trading, choose a broader period. We recommend that you decide on a period which seems to give as much information as possible. Later, when you adjust your trading system, you can leave the best alternative. Now let’s proceed to choosing tools which will provide basis for your trading system. In theory, a trend is formed with a series of successive highs and lows. These points complete continuation patterns such as Flag, Pennant, and Triangle.
Therefore, continuation patterns can be the first part for analysis with the use of the toolset. We are most interested in completion of the pattern. In addition, you have to implement a trend-following indicator to make sure that the existing trend will continue. You may find useful a moving average (MA) or even two moving averages with different periods like 21 and 34 (Fibonacci numbers). There is no doubt you need at least one oscillator, because the abovementioned patterns are formed in a channel and oscillators are most helpful when the price is consolidating in a range. Slow stochastics will be a perfect choice in this respect.
Here is an example of a chart where several technical indicators are applied:
You can see a full set of tools used to develop an automated trading system. Stochastics, 21 and 34 MA, and trend lines (red dashed lines) indicate the formation of a continuation pattern called the Pennant.
As soon as you have decided on a strategy and an armory of technical indicators, you start analyzing charts and spotting the signals. To begin with, you make analysis in retrospective.
The market goes through a correction (2). The previous price movements together with a moving average (1) indicate that the market is in an uptrend. This means that a continuation pattern is likely to occur on the chart (in this case the Pennant has been formed). That is why you should consider entering a long position, or buying the asset. Please pay attention that both lows of the correction were followed by price divergence on the stochastics (3). When the price broke above the moving average (4), it was giving the confirmation signal that the ongoing trend is set to continue. At point (5) the Pennant is completed and the uptrend is continuing as the formation of the pattern is considered complete after the breakout of the trend lines. At point (6) occurs a confirmation signal because it is a common retracement which was testing the broken trend line for the support.
Now you need to form a chain of signals in order of their appearance:
the stochastics moves away from the overbought territory;
the price breaks below the moving average;
the breakout of the trend line which caps the Pennant;
the price tests the broken trend line for support.
It follows that you should try entering the market as soon as you receive the fourth signal. Now you define the point where to place the stop loss order. The best option is to place it below the moving average, closer to the breakout point (the point where the price breaks the moving average), below the trend line supporting the Pennant. The next step is to set the price targets when you would like to exit your position and the take profit level. In our previous tutorial devoted to continuation patterns, we wrote that the price target to keep the position open can be placed at the level prior to the formation of the pattern.
When the price breaks below a moving average, as well as when a short-term MA crosses below a long-term MA is a signal for early exit. As we see in the Figure below, the exit signal was received sooner than expected. The price broke a MA (7) indicating the time to open a reverse position, i.e. to go short.
The signal to exit the market appeared before the price met the target level. At the point 7 the price crossed both moving averages indicating potential trend reversal.
Your analysis cannot be limited to a single case. You should keep on examining the previous movements until you spot all possible chart patterns (Flag, Triangle) and find out as many examples of price action as possible. After that you can try to recognize the signals on a chart in real time. At this stage you will be able to analyze the importance of a particular signal and determine the most suitable entry points.
The next step is optimization.
This time you can adjust the parameters of the employed technical instruments, such as the stochastics and moving averages, try out your trading system in different time frames and so on. When you get the desired results you can backtest your trading system while trading a demo account. The more tests you give the better. The ratio of right to wrong signals of 70/30 is considered enough for successful trading.
As soon as you choose one or two automated technical indicators, you need to test them. Backtesting is usually carried out in two stages. First, you test them on available. Second, you repeat the procedure in life trading. Backtesting helps to discover the pitfalls rarely mentioned in manuals. You learn how to recognize signals of an indicator. In retrospective, everything seems so clear and simple, but the online trading requires certain skills. Eventually, you will understand that books do not always describe the actual signals, and you will make your own list of signals.
To begin with, you need to find out whether a chosen indicator suits you.
You just have to calculate a number of correct signals based on the available data. If you are satisfied with the results, the next step is to optimize those indicators. In other words, you have to get the highest possible number of correct signals. The most popular method of optimization is to substitute the variables used to calculate the indicator. Mathematical optimization (formulas) is possible, but it is more suitable for those who are very good at mathematics or understand the market perfectly well. Meanwhile, it is not necessary that you use the same values for different time frames. For example, the 10-day moving average on a daily chart is very likely to give correct signals. At the same time, the best period of the moving average for the intraday trading is 5 or 7 days. The most important thing is to identify when the indicator gives the highest number of correct signals. That is the major objective of optimization.
The second stage of the backtesting is carried out with the use of the optimized indicators. By this point, indicators must give correct signals online, and you have to be able to spot them. In real time, the number of correct signals may be different, so you might need to optimize them once again.
Next, you combine signals, indicators and methods of classic technical analysis into an overall signal that determines entry and exit points in the market.
For example, the following development can signal an entry point to go short:
The market is in an uptrend, and the latest price movements formed the Engulfing pattern. When the reversal pattern was formed, MACD does not reach a new high. It means the price divergence is possible, and the further decline confirms that. The breach of the uptrend line once again confirms previous signals of the probable trend reversal. When the stochastic oscillator falls beyond the overbought level, and some downside movement occurs, the signal to open short positions is complete.
Trading systems are rarely optimized up to 90 percent of successful signals. Do not wear yourself out trying to achieve impossible things. The ratio of 70/30 can be considered enough to trade successfully on Forex.
Now try to develop your own trading system. When you create a trading system, you should follow a logical concept based on theoretical knowledge and observations.
While you are still a novice in the market, you’d better stick to a simple rule of trend trading. That is why you have to design a trading system with the use of trend-following indicators. First, you choose the financial instrument you are going to trade. Then you decide on a time frame depending on what kind of trading you prefer. In case of the intraday trading you should pick a short period from five to thirty minutes. If you prefer a longer-term trading, choose a broader period. We recommend that you decide on a period which seems to give as much information as possible. Later, when you adjust your trading system, you can leave the best alternative. Now let’s proceed to choosing tools which will provide basis for your trading system. In theory, a trend is formed with a series of successive highs and lows. These points complete continuation patterns such as Flag, Pennant, and Triangle.
Therefore, continuation patterns can be the first part for analysis with the use of the toolset. We are most interested in completion of the pattern. In addition, you have to implement a trend-following indicator to make sure that the existing trend will continue. You may find useful a moving average (MA) or even two moving averages with different periods like 21 and 34 (Fibonacci numbers). There is no doubt you need at least one oscillator, because the abovementioned patterns are formed in a channel and oscillators are most helpful when the price is consolidating in a range. Slow stochastics will be a perfect choice in this respect.
Here is an example of a chart where several technical indicators are applied:
You can see a full set of tools used to develop an automated trading system. Stochastics, 21 and 34 MA, and trend lines (red dashed lines) indicate the formation of a continuation pattern called the Pennant.
As soon as you have decided on a strategy and an armory of technical indicators, you start analyzing charts and spotting the signals. To begin with, you make analysis in retrospective.
The market goes through a correction (2). The previous price movements together with a moving average (1) indicate that the market is in an uptrend. This means that a continuation pattern is likely to occur on the chart (in this case the Pennant has been formed). That is why you should consider entering a long position, or buying the asset. Please pay attention that both lows of the correction were followed by price divergence on the stochastics (3). When the price broke above the moving average (4), it was giving the confirmation signal that the ongoing trend is set to continue. At point (5) the Pennant is completed and the uptrend is continuing as the formation of the pattern is considered complete after the breakout of the trend lines. At point (6) occurs a confirmation signal because it is a common retracement which was testing the broken trend line for the support.
Now you need to form a chain of signals in order of their appearance:
the stochastics moves away from the overbought territory;
the price breaks below the moving average;
the breakout of the trend line which caps the Pennant;
the price tests the broken trend line for support.
It follows that you should try entering the market as soon as you receive the fourth signal. Now you define the point where to place the stop loss order. The best option is to place it below the moving average, closer to the breakout point (the point where the price breaks the moving average), below the trend line supporting the Pennant. The next step is to set the price targets when you would like to exit your position and the take profit level. In our previous tutorial devoted to continuation patterns, we wrote that the price target to keep the position open can be placed at the level prior to the formation of the pattern.
When the price breaks below a moving average, as well as when a short-term MA crosses below a long-term MA is a signal for early exit. As we see in the Figure below, the exit signal was received sooner than expected. The price broke a MA (7) indicating the time to open a reverse position, i.e. to go short.
The signal to exit the market appeared before the price met the target level. At the point 7 the price crossed both moving averages indicating potential trend reversal.
Your analysis cannot be limited to a single case. You should keep on examining the previous movements until you spot all possible chart patterns (Flag, Triangle) and find out as many examples of price action as possible. After that you can try to recognize the signals on a chart in real time. At this stage you will be able to analyze the importance of a particular signal and determine the most suitable entry points.
The next step is optimization.
This time you can adjust the parameters of the employed technical instruments, such as the stochastics and moving averages, try out your trading system in different time frames and so on. When you get the desired results you can backtest your trading system while trading a demo account. The more tests you give the better. The ratio of right to wrong signals of 70/30 is considered enough for successful trading.
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