How to develop your own indicators


As a trader it is important to develop your own view as to where you think markets may be headed. You can do this using fundamental analysis, technical analysis or even gut instinct. Whatever works as a means of predicting future price moves should be judged on its own merit.

Indeed there are hundreds of technical indicators that traders use to predict the market and some are better than others. However, there is an inherent flaw in using a well known technical indicator, which is that you will likely be getting the same trading signals as everyone else who uses it.

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The solution of course is to develop your own indicators and it isn’t as difficult as it seems.

Technical indicators

Indicators do not have to be particularly complex but they do need to make sense. The way to approach designing a technical indicator therefore is to first scour several different price charts looking for patterns.

By scanning lots of different situations over different time horizons you should be able to come up with a unique idea that you think may lead to profitable trading opportunities.

Once you have an idea, it is simply a matter of getting that idea on paper in the form of programming code, since nearly anything that you can see on a price chart can be distilled down into mathematical code.

Most trading platforms allow coding and if you are not too keen on doing it yourself, you can usually get a programmer to do it for you.

Once you have your own personal indicator written down in code, you can start adding buy and sell arguments and go about testing how effective it is on historical price data.

Fundamental indicators

Many traders forget that indicators can be designed to use fundamental data, not just price data alone.

It’s possible therefore to download economic data from many of the freely available sources on the internet and incorporate it into your investment decisions.

There are plenty of options around which can be combined into a composite indicator or simply used on their own.

You could, for example, create a composite indicator that measures the spreads between bond yields and takes into account the price earnings of stocks in the S&P 500 or one that keeps track of M3 money supplies in the economy and the price of oil.

By doing so, you could limit your account to only trade when certain fundamental conditions lineup.

Another idea might be to use fundamental factors as a filter for long or short trades.

For example, let’s say that the spread between interbank rates and t bills is higher than one (also known as the TED spread, an indicator which signifies credit risk and thus fear in the market). You could use this information as a filter and only go long safe haven currencies such as the US dollar or Swiss Franc. Similarly, it the TED is lower than one, the market is more optimistic so you might choose to only buy more risky currencies.

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