Which are the best intraday trading indicators?
Before using indicators, understand what an Indicator is and what it does.
What is an Indicator?
An Indicator is nothing but some sort of arithmetic function performed on the historic price or volume data and usually is presented through charts/graphics.
What does an Indicator do?
So given the definition of an Indicator, all that it does is it gives us a way of comparing past with the present in a normalized way. For example if you use moving averages, you know that the price was above moving average (MA) earlier now its below. So in a way a MA give you a reference to compare past with present. The time frames could differ, for an intraday trader, past 1 hour is “past” and for a positional trader it could be past few days that constitutes the “past”.
Hence, an Indicator is NOT a predictive tool, its only an analytical tool. Therefore they are called “Lagging” indicators
Sorry for being a broken record - All Indicators are Lagging in nature, hence they cannot Predict the price, they can only give us a reference to compare the present with the past.
But I have seen Indicators working - you may say?
A developing trader during a coaching session told me, Sandeep, why are you bothering me with all this probabilities, I can show you how indicators work. He went on to show me some Oscillators, he said “Look the moment the oscillator went into the Oversold zone, the price shot up”. I was laughing, and was telling myself “Not again”.
So in essence, this is what transpired, he showed me several instances of the oscillators working and I showed him several instances when the same oscillator did not work as intended.
Now, you may ask but it does work sometimes - Yes it does, and the reason it does it because of what is known in Psychology as “Self Fulfilling Prophesy”. In simple words, imagine if a whole lot of traders believe that the moment the indicator goes in oversold level it should go up - and they buy the stock - now because a lot of traders would buy, the price would go up bit for sure.
Now if you ask me what caused the price to go up? Was it the indicator or the “buying” which happened because of the beliefs of traders.
So what works and what do “professional” intraday traders use?
Here is what most professional traders do
- Do follow certain indicators, oscillators etc. knowing very well that they are not “Predictive” in nature. They use it only for context.
- Use better tools to understand market structure like - Market Profile Charts, Footprint Charts. These charts work more like an x-ray and tell us whats happening inside a specific 3 or 5 min time frame. For example if the price moved from 100 to 110 in 5 minutes, these charts would tell you at what point in the given price range did the maximum transaction happen. For example its quite possible that more than 70% of transactions happened at 101. It can also tell us that most transaction happened at 110, that makes a huge difference right? - Whichever way it is, Market profile charts give us better context by putting volume along with price. Now again, this too is not predictive, else everyone wold be using it and minting money forever. All that Market Profile tools do is, give you a better and more realistic sense of whats happening in the market. More about it here - Market Delta Videos.
- Use probabilities - Now if indicators are not predictive, what else is. Well this is where the use of market statistics helps us take more informed decisions. Probabilities can be used in different contexts. Let me start with some context and basics
- Probabilities - If X happens - how many times does Y happen? If prices crosses VWAP, how long does it stay above VWAP in a specific stock/index etc.
- You may be able to calculate - 90% - It stays at least for 5 mins. 60% of times it stays for 45 minutes. 50% of times 60 minutes and so on.
- Now that you know there is a probabilistic edge in what you are doing, meaning there is a greater than 50% probability of a specific event to occur, all that you need is to participate in as many occurrences as possible and let the probabilities work in your favor. So long as you don’t change any of the variables, probabilities would work it’s magic.
- At any given point of time, there could be multiple probabilities that one can analyze and figure out, a bit of hard work, but then once you get it right, it works.
- You may ask? Why do people not use probabilities then? -
- Not as intuitive as an indicator - People want easy peasy stuff. Hard work/analytical work is not something a lot of people can do, people are looking for shortcuts in the wrong place,usually ie.
- Most people, lack basic critical thinking and reasoning skills - I can vouch for this as I have been a faculty in a b-school and I coach traders. I think this is partly because of our rote based education system. Hence most people keep looking for that holy grail indicator, which is some sort of a never never land. Just the way some people look for that ultimate qualification/degree which would lead them to the road to riches. But doesn’t work.
- Difficult to use probabilities, across stocks/asset classes - Most retail traders trade several stocks + indexes etc. Each may have its own specific probabilities, its almost impossible for retail traders to think probabilistic-ly across several stocks. They don’t have a research team to back them. The only way out is to stick to a select few indexes or stocks and work with them.
These are the points that come to my mind now, will update if I realize I have missed something. Hope this helps you become a more informed trader.