In trading, technical indicators are intended to help traders identify entry and exit points for their positions. Individual day traders are known to heavily rely on these trading tools, but do professional traders use indicators as well?
Professional traders who rely on technical analysis use indicators. Professional traders who do not rely on technical patterns tend to keep the use of indicators to a minimum, if at all. Trading indicators analyze the statistical trends of price movements and trading volume to predict market trends.
This article will explore the reasons why some traders use indicators and others do not. Whether you are new to trading or someone experienced encountering challenges in using indicators in your trading plan, understanding the professional trader’s approach to indicators will help you form a better opinion on whether you should incorporate more or fewer indicators in your trading.
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Table of Contents
What are Technical Indicators? And, Why Traders Use Them?
To more easily grasp why some professional traders may be more prone to use indicators in their trading while others to shun them, you need to have a basic understanding of the different types of technical indicators and how they are used.
There are two kinds of indicators used in trading. These are leading and lagging indicators. In turn, both these indicator categories can be further classified into four types: trend, momentum, volatility, and volume indicators.
Leading Indicators
A leading indicator provides a signal to a trader before a shift in a current trend in the market takes place. They are meant to lead price movements allowing a trader to catch trend reversals or new trends early.
Lagging Indicators
A lagging indicator is only observable after the price action has taken place. For this reason, they are relied upon to confirm changes in a market trend or to gauge the strength or weakness of current trends.
Trend Indicators
Trend indicators are supposed to show traders the direction that the asset that they are trading in is moving and is expected to continue moving in the near future. These trends could be upward, downward, or flat.
Moving averages are the most common example of a trend indicator.
Momentum Indicators
A momentum indicator will provide information to a trader regarding the speed at which an asset’s price is moving in a given direction. These indicators can assist a trader in spotting oversold or overbought conditions.
Many momentum indicators are oscillators, using two limits above and below a midpoint to gauge a current or gathering momentum’s strength. The Relative Strength Index (RSI) is an example of such an indicator.
Volatility Indicators
In trading, volatility refers to the rate that a trading asset’s price rises and falls. Volatility indicators serve to detect price movements that occur swiftly to indicate high volatility. Bollinger bands are a classic example of this type of indicator.
Volume Indicators
Across all asset classes, the volume at which an asset is trading is a reliable indicator of the current market sentiment. It can help to confirm the continuation or change in the direction of a trading asset’s price.
On-Balance Volume (OBV) and the Klinger Indicator are two of the most relied upon volume indicators.
2 Drawbacks of Technical Indicators That You Must Consider
Information Overload
There are hundreds of indicators that are available on trading platforms. It is not difficult for traders to become seduced by the variety of indicators and what they promise to track or detect. Such an abundance of indicators results in some traders overlaying indicators over indicators on their trading charts. It can result in information overload.
No matter how good the indicators are, if a trader is attempting to digest information from dozens of indicators simultaneously, something is bound to go wrong. The indicator may be timely in delivering its signal, but the trader may be slow to respond due to multiple other data and signals going off involving the open position.
Distractions
The presence of indicators, especially in large numbers, can distract traders from pursuing or adhering to sound trading strategies. The presence of indicators on a trading screen can cause some traders to lose focus.
Even worse, it can provoke some traders to chase setups or exits that are detrimental to their trading strategy. Too many indicators can make traders spend more time monitoring their screens than analyzing their performance and formulating new trading ideas.
How Different Professional Traders Use Techincal Indicators?
The term “professional trader” is frequently stretched to include successful retail traders. Following that lead, how professional traders use or don’t use indicators tends to follow the divide between retail and institutional traders.
Retail Traders
A retail trader is an individual trader who trades with their own money. Retail traders also tend to be the most prone to rely on indicators. The reliance on indicators is because many retail traders rely on technical analysis as a fundamental part of their trading strategy. Indicators are what fuel technical analysis.
At the retail trading level, indicators are essential to the following types of traders.
Intraday Traders and Scalpers
Day traders and scalpers trade in short time frames. The shorter the time frame, the more a trader would need to rely on indicators to set up entry or exit points. Therefore, it should be no surprise that successful day traders are among the professional traders that count the most heavily on indicators.
Multiple Timeframe Trading
Multiple timeframe trading involves trading one asset or different assets across different timeframes. Even though the same trading asset is involved across various timeframes, it will likely have different support and resistance levels. Likewise, volume and volatility may be more concentrated within the narrower timeframes than a broader timeframe.
This type of multiple timeframe trading can allow traders to hedge positions bought with a mid to long-term perspective with additional positions in the same asset except under a different timeframe.
At least one indicator of each of the four types described in this article should be used for multiple timeframe trading.
Trend Trading
Using the momentum of a trading asset to determine trading strategy is the key component to trend trading. It is common with traders who adhere to a long-short method of trading.
Since price action and momentum are involved in making entry and exit decisions with trend trading, momentum indicators are essential.
Institutional Traders
An institutional trader does not trade their own money. Instead, they do so for an institution or fund that they manage. Due to their large capitalization, they can engage in larger trades. In turn, this allows them the opportunity to participate in trading instruments that are not necessarily available to retail-level traders.
Institutional traders have access to IPOs, swaps, and forward contracts. Their size also makes it possible to negotiate trading fees and receive priority in the execution of trades. All of this means that institutional traders conduct a level and style of trading that is more focussed on risk management due to their scale.
Trades are often entered in a tiered fashion due to their large size. The methodology for preparing a trading plan at the institutional level is such that it is driven more by fundamental analysis than technical analysis.
This increased focus on fundamentals makes institutional traders less reliant on indicators. Some may avoid them entirely, especially when entering positions with a long-term horizon.
However, even if institutional traders are not as dependent upon or avoid indicators, the analysts who conduct the traders’ underlying research often rely on indicators for this work. As such, institutional traders may not actively use indicators but do benefit passively from them.
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Conclusion
The main divide between professional traders who rely on indicators and those who don’t is found between professional retail and institutional traders.
For the most part, retail-level traders will use at least a small set of indicators to determine high-probability entry and exit points. The number of indicators they use tends to be correlated to the timeframes they use to trade. The smaller the timeframe, the more indicators they use.
Institutional traders, however, due to their larger capitalization levels and what that implies, are less reliant on indicators.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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