Successful traders rely on reading price movement itself in order to find and manage trades. Novice traders that often lose money depend on technical indicators to decide whether to buy or sell. Indicators are derivatives of price and/or volume and are therefore lagging. Our decisions are to be based on price itself and the indicators can be used to help support our decisions but should never be taken as the decision maker themselves.
We can still use some technical indicators to filter out marginal trades and to assist us in determining the strength of the trend. When we have trend strength increasing, we are more likely to break out of the supply or demand zones and continue in the trend. However when the trend shows weakness, there is a higher probability of a bounce and either a retracement or reversal.
The key thing is to use the indicators correctly. Most books on trading are regurgitated notes on classic trading techniques that may work from time to time. We can’t make money from time to time and need something fresh and more reliable to depend on. That is why I am thankful for the instructors I have had as a past student and now work with at Online Trading Academy. They offer real strategies that have consistently worked in the markets.
Those of you who have been in my live courses or in my Extended Learning Track have seen me use a popular technical indicator with certain modifications. You are probably familiar with the Relative Strength Index or RSI. It is an oscillator that measures the strength of up or down moves in price relative to the stock’s previous price movements. The typical readings for this indicator are 70-30. A reading of 70% means that the stock is overbought and likely to drop soon. The RSI crossing below the 70% line is sometimes taken as a sell signal. Conversely, a reading below 30% shows the stock to be oversold and perhaps ready to rise. A buy signal is said to be generated when the RSI crosses above 30.
The problem with using the traditional signals of the RSI for buying and selling is that they will usually come after the price is moving away from supply or demand zones. To have low risk, high profit and high probability trading opportunities, we must buy at those demand zones and sell the supply zones. So how can we use the RSI when it is always giving us late signals? Well I look to use it as a filter to prevent me from taking trades that have a lower chance for success.
In a strong uptrend the RSI will typically use 40 as a support level. There are retracements downward in an uptrend, but as long as the RSI does not dip below 40 when price retraces then I am likely to trust my demand zones to buy. Should the RSI move below 40 during a retracement, then price will be less likely to make new highs on the next impulse up.
When price is in a strong downtrend, the RSI will not rise above 60 when prices retrace up to supply zones. Should the RSI move above the 60 when price is moving up to the supply zone, then it is unlikely to make new lows once it starts to join the trend down from that supply zone. This means I would have less reward potential in a short trade. I may want to look for a better opportunity.
You should only trade using the supply and demand zones to enter the dominant trend. You may also choose to add some technical indicators to your chart to filter trades. You must remember that they are only confirming your trading decisions and should never be used to make trading decisions themselves.