Probably the first tools for the creation of trading strategies every new trader is exposed to are technical indicators. These – which I have studied in detail within my “indicator series” of posts – are simply a given set of mathematical calculations done over price which reflect certain aspects of the market which may not be easy to see for traders with the naked eye. New traders usually approach indicators in the wrong way – using them without even the most basic understanding about their functions and nature of the calculations they carry out – reason why failure with them is much more common than success. In their race to find the “best indicator” new traders usually start to search for more complex indicators which may “lag less” (although lagging, as I have explained on previous posts, is a very nonsensical concept) but certainly profitability does NOT depend on the complexity of the tools used, but on the understanding built behind them and the way in which they are used.
I will dedicate today’s post to the exploration of these “advanced indicators” world, what the possibilities behind it are and what they could be useful for. Through the next few paragraphs I will give you my definition of an “advanced indicator” making emphasis on what these type of indicators may help you do and what they may NOT help you achieve. You will see that although advanced indicators present traders with new potential opportunities to easily exploit more “obscure” inefficiencies they in no way present a probability to profit beyond that of the regular indicators. In the end you will see that – as always – the important thing is to be fully aware and totally understand the nature of what is being used and what it can and cannot do for you.
When we explore the world of indicators we quickly see that there are different degrees of complexity around the calculations they carry out and the information they display. While an indicator like a simple moving average may be considered “simple” in both coding and concept, some other indicators – like the ADX – are evidently much more complex in nature. Since there is no formal definition of what an “advanced” indicator may be I will use a definition which I have created for this purpose. During the rest of this article we will consider as “advanced” any indicator which is derived from at least two distinct layers of calculations with the second layer including new information. This means that an “advanced indicator” is one that makes a calculation over price and then a calculation over that (with the introduction of some new information) . We could think of advanced indicators perhaps as “indicators over indicators” in the sense that they could be represented (at least in part) by an indicator being used over a “simpler” indicator.
What examples do we currently have of such indicators ? A very common example given as a “second generation” indicator is the Stochastic-RSI which uses a simple and clear connection between two well known indicators to display new information for the trader. This indicator is simply a Stochastic calculation over an RSI. The indicator displays – in simple terms – how close we are to the highest or lowest value the RSI has had within the past X periods while the RSI displays the percentage composition of net price movements to either down or upside within a Y period. We could therefore say that the indicator shows how close we are to the highest or lowest peaks of up or down trending momentum within an X period, with momentum being derived from strong movements through Y periods.
Indicators such as the above are useful because they can show you information which is quite difficult to determine with the naked eye or even with the presence of the “first layer” of complexity (in the above case, the RSI indicator). The above indicator could therefore be considered fundamentally more adaptive when compared to the RSI since it gives an indication of the presence of momentum peaks adjusted against the magnitude of the actual momentum which has been present within a pair through the period chosen on the RSI.
However this by no means suggests that profitable trading with these indicators is easier than with regular indicators. When you calculate mathematical expectancy values of their signals or attempt to design systems with them you run into the exact same problems as with regular indicators. Any strategy you design must be based on a sound understanding of what an indicator is showing you and attempting to “trade blindly” with an advanced indicators without a clear plan with a previous measurement of its long term edge is bound to bring as much failure as doing so with a regular indicator.
Indicators that have multiple layers therefore allow us to get more insight into the market and explore inefficiencies which might not be so easily exploitable with regular indicators but their success is not warranted as a simple merit of their added complexity. New traders should understand here that an indicator has no “inherent quality” regarding its potential profitability as the responsibility to generate profit from an indicator comes from the trader who decides how to use the tool in question and how to implement strategies to exploit what the indicator is actually saying. So for those “color traders” (traders who like to trade indicators only through some signal or color change) out there, my advice is quite simple, start to understand what you’re doing and learn to interpret what the indicators are telling you through an understanding of the calculations they make, failing to do so will only mean failure in the long term, regardless of the complexity of the indicators you’re using.
There are certainly tons of advanced indicators out there, each one with a very valuable contribution to the possible spectrum of inefficiencies that we might want to exploit. Indicators such as the Laguerre RSI, BB-MACD and John F. Ehler’s Fisher transform based indicators allow you to take a look into the market at a “deeper level” to find inefficiencies which are potentially much harder to find when visually exploring charts. This doesn’t mean that these indicators – as I have said before – are anything better than “classic ones” but merely that they offer new opportunities which – to exploit successfully – still require an in-depth understanding of what is being done.
Certainly there are a ton of things that could be done with the above indicators and it will probably make sense to include them within genetic frameworks (like Coatl) to exploit different “layers” of market inefficiencies. If you would like to learn more about mechanical trading and how you can build your own systems based on an understanding of what you’re doing please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach towards automated trading in general . I hope you enjoyed this article ! :o)