From the May 2013 issue of Futures Magazine • Subscribe!

Creating custom indicators

Get testy

The next step in the development process is to test the indicator by monitoring it in a live market. The purpose of testing is three-fold:

  • To make sure the indicator does what you expected it to do
  • To determine if the indicator’s appearance is what you intended
  • To establish if the concept is valid

Once an indicator has been developed, it may not be a big stretch to incorporate it as part of a trading strategy that can be tested and eventually traded using some level of automation, if desired. By utilizing the indicator in a strategy, a trader quickly can determine if the trading concept has any merit.

As the flow chart indicates, if testing reveals that the indicator does not perform as expected for any reason, it needs more work. This might entail minor revisions, such as tweaking one line of code, or the trading concept may need to be revised to develop a more useful trading tool.

Once the development is complete and the indicator has proved to be useful, it is ready to be used in the markets. It is up to each trader to decide how to apply an indicator to the markets that he or she trades. It is important not to confuse technical indicators with strategies. Indicators provide a visual representation of some type of market condition. Strategies, on the other hand, are objective sets of rules that specify the exact conditions for trade entries and exits. While strategies can be based on multiple trade filters and triggers, including indicators, it is the strategy—and not the indicator—that determines when a trade is made.

Custom indicators can be important additions to any trader’s toolbox because they allow traders to identify specific market conditions rather than being limited to a trading platform’s standard selection of indicators.

 

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