No technical indicator is infallible.
To reduce the chances of false signals—where actual price movement diverges from what the indicator suggests—technical indicators are often combined with other tests or indicators to enhance their reliability.
This process is known as waiting for confirmation of the signal generated by the technical indicator.
These additional tests are commonly referred to as "filters."
Filters typically fall into the following categories:
- Time: The signal must persist for a certain duration. For instance, a 50-day moving average should remain above a 200-day moving average for at least three trading days.
- Magnitude: The signal must fall within a specific range. For example, an oscillator may need to be above 80% or below 20%.
- Volume: Indicators tend to carry more weight when they are based on higher trading volumes.
Different indicators may be more effective over specific time frames, so it's important to select those that align with your trading horizon.
The frequency of trading signals is another factor to consider.
If you're a day trader, you'll prefer indicators that produce numerous signals throughout the day. A swing trader, on the other hand, may seek fewer signals.
Combining multiple indicators with price action analysis generally results in fewer signals and lower trading costs.
Remember, technical indicators are just that—indicators.
They do not guarantee that prices will move in a particular direction.
With technical analysis, it’s often difficult to determine whether a trend reversal is genuine or a false signal until after the fact.
This is why analyzing charts across multiple time frames is recommended to provide additional context to your interpretations.
