The Best Way to Use Our Indicators
I often get asked by traders what is the best way to use a particular indicator. This is what I tell them:
The answer is... there isn't one right answer. There is no one-size-fits-all trading strategy for any of our indicators. There are a lot of factors that go into developing a trading strategy, and it is all based on your personal risk tolerance and preferences.
Many of our indicators either give entry signals or tell you where key price levels are. But that does not mean that you should take a trade every time you get an entry signal, or every time price hits one of the key price levels. You can and should use a combination of other indicators and filters, which will help you avoid setups with lower probabilities or worse risk/reward potential.
Once you decide to take a trade, you then have a few choices on how to enter the trade. Do you enter immediately, or wait for confirmation? Do you use a market order or try to get a better price with a limit order? Do you enter the trade all at once, or scale into the trade gradually?
And once you’ve entered the trade, you have even more options for how you manage the trade. Keeping in mind that a tighter stop loss generally will improve the risk/reward ratio, but will also decrease the probability of success, where will you place your stop loss? Will you trail the stop? How will you take profits? Will you use limit orders at your target profits, or will you look for certain price patterns or indicator conditions to exit the trade? Will you scale out of the trade in multiple lots? Will you exit the trade after a certain amount of time, or let it run until a target or stop is hit?
All of these factors will differ depending on the time frame and market traded. Stocks behave differently than commodity futures, which behave differently than forex. Every market and time frame has different characteristics, and will require different risk management practices.
Because of all the factors that go into developing a strategy, it is usually a good idea to backtest a strategy before trading it live. This will allow you to see what works and what doesn't, and even let you optimize the input parameters. If done right, backtesting gives you the opportunity to figure out a strategy that works in your chosen market with your particular set of indicators, given your particular risk tolerance and risk management practices. Since this is different for every trader, we are not in the business of selling trading strategies. Instead, our indicators are tools that can be used as part of your personal strategies.
While I prefer TradeStation for backtesting, Thinkorswim does offer some basic backtesting capabilities that make it useful for quickly determining whether a strategy is viable or not. If you need help setting up a backtest in either Thinkorswim or TradeStation, feel free to contact us to make a request.