To find the best technical indicators for your particular trading approach,
test out a bunch of them singularly and then in combination. You may
end up sticking with, say, four that are evergreen or you may switch off
depending on the asset you're trading or the market conditions of the
day.
Regardless of whether you're day-trading stocks,
forex, or futures, it's often best to keep it simple when it comes to
technical indicators. You may find you prefer looking at only a pair of
indicators to suggest entry points and exit points. At most, use only
one from each category of indicator to avoid unnecessary—and
distracting—repetition.
Combining Day-Trading Indicators
Consider pairing up sets of two indicators on your price chart to
help identify points to initiate and get out of a trade. For example, RSI and moving average convergence/divergence can be combined on the screen to suggest and reinforce a trading signal.1
The relative strength index (RSI) can suggest overbought or oversold conditions by measuring the price momentum of an asset. The indicator was created by J. Welles Wilder Jr., who suggested the momentum
reaching 30 (on a scale of zero to 100) was a sign of an asset being
oversold—and so a buying opportunity—and a 70 percent level was a sign
of an asset being overbought—and so a selling or short-selling
opportunity.2
Constance Brown, CMT, refined the use of the index and said the
oversold level in an upward-trending market was actually much higher
than 30 and the overbought level in a downward-trending market was much
lower than 70.3
Using Wilder's levels, the asset price
can continue to trend higher for some time while the RSI is indicating
overbought, and vice versa. For that reason, RSI is best followed only
when its signal conforms to the price trend: For example, look for
bearish momentum signals when the price trend is bearish and ignore
those signals when the price trend is bullish.
To more easily recognize those price trends, you can use the moving average convergence/divergence (MACD) indicator.4
MACD consists of two chart lines. The MACD line is created by
subtracting a 26-period exponential moving average (EMA) from a
12-period EMA. An EMA is the average price of an asset over a period of
time only with the key difference that the most recent prices are given
greater weighting than prices farther out.
The second line is the signal line and is a 9-period EMA. A bearish
trend is signaled when the MACD line crosses below the signal line; a
bullish trend is signaled when the MACD line crosses above the signal
line.
Choosing Pairs
When selecting pairs, it's a good idea to choose one indicator that's considered a leading indicator
(like RSI) and one that's a lagging indicator (like MACD). Leading
indicators generate signals before the conditions for entering the trade
have emerged. Lagging indicators generate signals after those
conditions have appeared, so they can act as confirmation of leading
indicators and can prevent you from trading on false signals.5
You should also select a pairing that includes indicators from two of
the four different types, never two of the same type. The four types
are trend (like MACD), momentum (like RSI), volatility, and volume.6
As their names suggest, volatility indicators are based on volatility
in the asset's price, and volume indicators are based on trading volumes
of the asset. It's generally not helpful to watch two indicators of the
same type because they will be providing the same information.
Using Multiple Indicators
You may also choose to have onscreen one indicator of each type,
perhaps two of which are leading and two of which are lagging. Multiple
indicators can provide even more reinforcement of trading signals and
can increase your chances of weeding out false signals.
Refining Indicators
Whatever indicators you chart, be sure to analyze them and take notes
on their effectiveness over time. Ask yourself: What are an indicator's
drawbacks? Does it produce many false signals? Does it fail to signal,
resulting in missed opportunities? Does it signal too early (more likely
of a leading indicator) or too late (more likely of a lagging one?)
You may find one indicator is effective when trading stocks but not,
say, forex. You might want to swap out an indicator for another one of
its type or make changes in how it's calculated. Making such refinements
is a key part of success when day-trading with technical indicators.