Do Indicators Really Work?

No matter what instrument is traded, be it stocks, futures or forex, chances are most people trading it are obsessed with finding the perfect indicator, and the perfect entry point. As a professional trader, I'll let you in on a little secret about your favorite indicator: it probably does great, 50% of the time - before factoring in commissions and slippage.

Most indicators out there, including the most popular ones like moving averages, stochastics, relative strength, etc. all work about 50% of the time. Just as good as tossing a coin. This truism probably applies to 95% of the indicators out there.

The 5% of indicators that do work are usually closely guarded secrets, not available for sale to the public anywhere. After all, if you had a golden goose, would you sell it?

Browse the Internet for a while, and you'll see fabulous indicators for sale. You can even find them on auction sites! Of course, you will only see the excellent examples of how the indicator works, not when it breaks down. Don't be fooled. They all break down under some conditions. There is no "Holy Grail" indicator.

So, let's say you buy an indicator or indicator package. Can buying it really be that bad? In a word, yes. In fact, the more money you spend, the worse it is, and not just because you spent a lot on it.

Any indicator you pay for is dangerous, because once you "invest" in an idea, you will spend a lot of time to make it work in your systems, even if that means unintentionally curve fitting or over-optimizing. Spending money on an indicator gets you emotionally involved, and that can spell trouble. Typically, you consciously or subconsciously have the need to be right in your purchase, and that will eventually hurt you.

What is the solution? Spend time studying and observing the markets, and then create your own indicator that numerically describes what you see. Or, develop a trading strategy that doesn't use any indicators at all. Chances are, with some hard work, you can find something that is better than flipping a coin.