4 Questions to Ask When Picking Technical Indicators

As most trading analysis courses will tell you, there is no “Holy Grail” indicator that can guarantee profits in the forex market.

That doesn’t mean you should give up the search for the “best” technical indicator that works for you.

Think of technical indicators like kitchen utensils…Gordon Ramsay and a college freshman might both own spatulas, but only one of them can flip an omelet without creating a disaster.

Don’t forget that you can always mix and match indicators or tweak their settings to come up with a consistently profitable strategy. The possibilities are endless!

But before you transform your chart into a rainbow of colorful indicators, let’s get back to basics.

Start by answering these four key questions first:

1. What do you want to use the indicator for?

As with most activities, the choice of tool or equipment boils down to what exactly you want to do with it.

You don’t use the wide camera lens for shooting portraits or pick up the bread knife for slicing meat, do you? Similarly, you wouldn’t use a hammer to fix a leaky faucet (unless your plumbing philosophy is “hit it until it works”).

If you like catching market tops and bottoms, then oscillators like Stochastic or RSI could be your best bet.

If you’re scratching your head and wondering what all this is about, then you should go back to our School of Pipsology and read up on momentum indicators and oscillators!

2. Do you know how the indicator works?

It also helps to understand how a technical indicator is built so you can read its signals more clearly.

You don’t need to memorize the formulas. Nobody’s asking you to tattoo RSI math on your forearm. But you should know what data goes into the indicator, like the average of the last X closing prices, the relationship between recent highs and lows, or price changes over a certain number of candles. That gives you a better sense of what the indicator is actually telling you.

For each indicator, ask:

• Is this indicator leading (trying to predict future price) or lagging (confirming past movement)?
• What specific price data does it use? (Opens, closes, highs, lows, volume?)
• Does it work better in trending or ranging markets?
• What is it actually measuring? (Momentum, volatility, trend direction?)

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3. When does the indicator fail?

It’s not enough to just know how the technical indicator works. It’s also useful to be alert to when it could fail.

After all, there is no foolproof, sure-win indicator out there, so you should be mindful of market scenarios wherein it might have some drawbacks.

For instance, moving averages don’t really give reliable signals in range-bound markets, so you might get caught up in choppy price action if you follow crossovers blindly.

Some oscillators tend to anticipate reversals too early, so you could get prone to fakeouts if you rely on leading indicators with the wrong parameters.

Here are some of the more common indicator failure points:

• Moving averages during sideways markets (like watching paint dry, but less profitable).
• RSI and Stochastic are giving false “overbought/oversold” signals during strong trends.
• MACD crossovers that happen after the move is nearly over (thanks for nothing!).
• Bollinger Bands expand and contract, but tell you nothing about the direction.

This brings us to the last question…

4. What settings should you use?

Once you’ve picked the indicator or indicators you want to use in your strategy, the next step is figuring out the right settings.

The key thing to remember is that shorter/lower settings lead to more sensitive indicators that generate more signals. On the other hand, longer/higher settings give less frequent signals and tend to have a lag.

So the real question is: where’s the sweet spot between fast but messy signals on one end, and slower but cleaner signals on the other?

But if you prefer settings that are able to incorporate the latest market conditions or have a good track record with other indicators, then the answer could be found in backtesting.

Just remember that optimizing for the past doesn’t guarantee future performance,

Here are tips for Indicator Settings:

• Adjust timeframes to match your trading style (scalping, day trading, swing trading, position trading).
• Consider market volatility when setting parameters (high volatility = longer settings).
• Test multiple settings across different market conditions.
• Use indicators in combination with price action analysis.
• Remember: The best settings are the ones that stop you from losing money.

Indicators are tools, not crystal balls.

By answering these four questions honestly, you’ll minimize experiencing the pitfalls of traders who blindly follow indicators without understanding what makes them tick.

Remember: The goal isn’t to find the perfect indicator. It’s to find the perfect indicator for YOU, your psychology, and your trading style. That’s the real Holy Grail.

This article covers how to pick technical indicators that actually fit your trading approach, but knowing which questions to ask is only part of the picture. Premium members can read our lesson:

📖 How to Design Your Trading System: The 5-Step Framework

Reading this helps you understand how to build indicator selection into a complete trading system, why most systems fail before a single trade is taken, and how to answer the five questions every strategy needs to get right.

And if you’re not a Premium subscriber yet, now’s a good time to sign up.

With Babypips Premium, you get full access to School of Pipsology lessons that help you understand not just which indicators to use, but how to fit them into a system that’s actually built around the way you trade.

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