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Technical indicator composites act as a single market indicator but include multiple technical indicators. They provide traders with more accurate market signals and reduce the impact of individual indicator failures, leading traders to make better trading decisions.
In this article, we will discuss all about technical indicator composites.
What are technical indicator composites?
Technical indicator composites are a group of two or more technical indicators that provide traders with an overall view of market momentum, trends, volatility, etc. Combining multiple indicators gives traders more accurate trading signals and reduces a trader’s reliability on a single indicator.
How to construct technical indicator composites?
- Select indicators: Traders should choose indicators that work well together. For example, traders can combine trend-following and momentum indicators for more accurate entry/exit signals.
- Assign weights: Each indicator should be assigned specific weights based on its reliability and importance in signal generation.
- Normalize the indicators: All indicators should be on a comparable scale. This means that the output of each indicator should be normalized to a standard range.
- Aggregate: Next, traders should combine all the weighted indicators into a single composite value. This can be done via simple mathematical calculations like addition, averaging, etc.
- Interpret: Finally, after setting clear rules for interpreting composites, traders should interpret entry/exit signals.
*This is an example only to enhance a consumer’s understanding of the strategy being described above and is not to be taken as Blueberry Markets providing personal advice.
Features of technical indicator composites
Increases signal accuracy
When multiple technical indicators are combined, market noise is filtered out, and false signals are reduced. This allows the trader to confirm trends more accurately and with better predictive power.
Gives streamlined analysis
Composites combine multiple data points into a single value/trade signal. This makes forex analysis straightforward and provides traders with a unified market picture.
Enables customizable metrics
Technical indicator composites allow traders to align different trading timeframe strategies and risk appetites. This provides traders with trading insights into their trading style.
Improves flexibility
Each trader can select a group of indicators that they are comfortable with. They can also skip indicators that are unreliable or take a tough time computing.This provides traders with ease of technical analysis.
Types of technical indicator composites
Composite index
A composite index combines different technical indicators to create a single metric that provides a view of the overall market sentiment.
There are different composite indices, such as the relative strength index (RSI), which combines RSI and simple moving average; the composite trend oscillator, which combines different oscillators; and more.
Volatility-volume composites
Volatility-volume composites combine measures of price volatility and trading volume in the forex market. They provide traders with trend strength and information about the sustainability of price movements.
An example of a volatility-volume composite is the Bollinger band with an on-balance volume (OBV) composite, which provides traders with a dynamic market analysis.
Custom-built composites
Custom-built composites are indexes that can be personalized to specific trading strategies and objectives. Traders can combine whatever indicators they feel suits their trading style the most.
These indicators allow traders to not depend on pre-made composites and cater to individual trading preferences.
Advantages and risks of technical indicator composites
Advantages
- Reduced impact of single indicator failures: They reduce the weakness of an individual indicator by combining the strengths of multiple indicates
- Adaptability to different markets: Technical indicator composites can be customized to suit different markets, market conditions, and timeframes
- Cross-validation: Traders can confirm signals across multiple indicators, mitigating the risk of dales signals
Risks
- Data overlap: When similar data across different indicators is used, it can sometimes lead to redundant information due to overuse
- Sensitivity to market noise: Combining multiple indicators can increase market noise due to similar data, leading to minor price fluctuations
- Neglects fundamental factors: Technical indicator composites only focus on the technical charting of a forex pair and not the fundamental factors that influence market prices
How to trade forex with technical indicator composites?
Define trading objectives
Traders should identify specific trading goals to select suitable technical indicators. Different indicators suit trading objectives, such as minimizing losses, maximizing gains, and achieving long-term gains.
Select relevant indicators
Choose technical indicators that align with the trading objectives. Traders can focus on factors such as momentum, trend direction, volume, and more. They should remember to combine different types of indicators to avoid overlap.
Create/access a composite indicator
If traders wish to custom build a composite indicator, they can combine the selected indicators mathematically or via their trading platform. On the other hand, traders who do not want to customize the composites can access existing composite indicators that the trading platform offers.
Backtest the composite indicator
Traders should backtest the composite indicator to analyze the indicator’s accuracy in past market conditions. For example, suppose the trader wants to take a position in EUR/USD. In that case, they can test the composite over the past six months of the pair’s historical data to evaluate the pair’s performance during different market phases.
Traders can also assess the composite’s reliability by evaluating its performance metrics, such as win rate, gains, drawdowns, Sharpe ratio, and more.
Integrate with the trading strategy
Traders should ensure that whatever indicators they choose in the composite align with their short—and long-term strategy goals. This will help them establish clear entry, exit, stop-loss, and take-profit orders.
Implement in live trading
After testing the composite across different market conditions, traders can finally use it in live markets. It is suggested that traders start with small positions and enter big positions as they are confirmed about the composite’s reliability.
*This is an example only to enhance a consumer’s understanding of the strategy being described above and is not to be taken as Blueberry Markets providing personal advice.
Improving signal accuracy with technical indicator composites
Technical indicator composites are a boon for traders as they offer a compressive market view with reduced market noise. However, if not used properly, they can lead to information overload and overwhelm the traders. Hence, traders should always ensure to combine technical indicator composites with fundamental factors before making a final trading decision.
Disclaimer: All material published on our website is intended for informational purposes only and should not be considered personal advice or recommendation. As margin FX/CFDs are highly leveraged products, your gains and losses are magnified, and you could lose substantially more than your initial deposit. Investing in margin FX/CFDs does not give you any entitlements or rights to the underlying assets (e.g. the right to receive dividend payments). CFDs carry a high risk of investment loss.
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