John Jagerson

Too Many Indicators Can Hurt Your Trading

    Tweet This

Free Trading Guides

I hear investing "instructors" suggest that adding several technical indicators will increase the probability of a successful trading outcome. This is a fallacy that plagues a lot of traders, especially new traders.

Trading the market is not just a numbers game, but there are some things we know about statistical analysis that can help you understand why this is a fallacy and why it can hurt your trading returns.

Assume that you are encouraged to use three different technical indicators.

The first is a stochastic that has delivered a 40% probability of a successful trade in the past. The second indicator is a MACD with a 30% probability of success. The final indicator is a moving average with a 20% probability of signaling a successful trade.

If you wait for all three indicators to agree, what is your probability of a successful trade?

Many of the instructors and authors I have seen would suggest that your probability is cumulative. Therefore, based on the numbers above your probability would equal 90%. It doesn't take long for traders to realize that simply adding indicators does not actually result in those kind of returns -- why not?

Technical analysts are indicators to make a statistical estimate of a successful trade outcome. However, because one technical indicator does not affect another, the analysis is being conducted "with replacement." That is a statistician's way of saying that because the indicators cannot affect each other, merely adding more of them to a chart will not increase the probability of being right.

In fact, from a statistical perspective, the probability of a successful outcome is always going to be equal to the most-accurate indicator or 40%.