In developing a forex trading strategy, traders often believe that the best thing to do is following only a single technical indicator. Sometimes this is really the right choice but some other times it is better to use a combination of indicators. It is not always easy to understand what is the best combination of technical indicators to use because, if a trader uses the wrong ones, he does not have a correct view of the market trend and this can lead him/her to take bad trading decisions.
Theoretically, all technical indicators are useful if used in the right way, but, at the same time, they each can become useless or even counter-productive if used in the wrong way. If a trader only use a single indicator to analyse the forex market, there may be certain trends or volumes that are not possible to detect.
By combining a multitude of technical indicators into a single trading strategy, a trader can achieve a better profitability while limiting the trading risk. In order to build a successful multi-indicator strategy a trader must folllow the following hints. First, a profitable strategy should avoid to use redundant indicators, in order to gain efficiency. If a trader use indicators which capture the same market variables the analysis process becomes slower and less effective.
To avoid this mistake, a trader needs to know how to classify technical indicators, which usually are divided into three main categories:
Trend Following Indicators detects whether a currency is overbought or oversold. Bollinger Bands and other trend following indicators aim to create a “channel” into which the price fluctuates. The correct detection of a clear channel enables a trader to see whether prices are close to breaking out or returning to normal.
Momentum Indicators, such as the Relative Strength Index (RSI), allow a trader to determine the direction and strength of a current price trend. If used correctly, opening a new trading position becomes less risky.
Volume Indicators help traders identify the existing relationship between price and volume. Increases in trading volume almost always result in an increase in price. However, these events do not always occur at the same time, which is why volume indicators are good for advanced forecasting. The On Balance Volume (OBV) and Money Flow are two of the most useful volume indicators.
Indicators belonging to each of these three categories basically detect the same market features. This is the reason why the use of a multi-indicator strategy should avoid to encompass types of technical indicators that belong to the same category, because the mistake a trader can make when using unfitting indicators is that he/she might actually think the trade signals are stronger if all indicators point in the same direction. Unfortunatelly, most of the time it is not so. Conversely, the joint use of a trend following indicator, of a momentum indicator and of a volume indicator can provide a complete picture of all the market features.