Knowing the Best Technical Indicators for Defensive Trading is paramount.
Without them you could not analyse the charts and you could not follow a Defensive Trading Strategy. However, the beauty of the Defensive Trading approach is that there is no strict rule as to which Technical Indicators are used.
It is completely up to the trader which exact combination of technical indicators they prefer to use. That being said, there is a preferred combination of types of indicators to use in Defensive Trading Analysis.
Jump Straight To The 4 Best Technical Indicators for Defensive Trading.
Types of Technical Indicators
As you may already know, there are two kinds of indicators, Leading and Lagging. As their names would indicate a leading indicator gives a signal before the new trend occurs, and conversely, the lagging indicator provides a later signal after the trend has started. Each has positives and negatives, one is delayed (lagging) but the other will give ‘fake’ indications (leading).
Technical Indicators can also be broken down into groups such as Moving Average Indicators, Oscillators and Momentum Indicators. Generally speaking, leading indicators are oscillators and lagging indicators are trend following or momentum indicators. As a trader, it should not matter what platform you prefer to trade on (MetaTrader or otherwise), all these Technical Indicators will be available to use to perform Technical Analysis of assets charts.
Let’s take a closer look at the key Technical Indicators for Defensive Trading that are available for traders to set up on their charts to perform their Technical Analysis.
Simple Moving Average (SMA)
The first Technical Indicators for Defensive Trading is a Moving Average Indicator, as the name suggests. SMA is a trend indicator which is expressed as a line chart over the candlesticks in the main section of a chart. Moving averages are a way of using a line chart to view the average of the closing price for a set period, on a continuous basis. They are often used in a variety of timeframes on the same chart in order to see a fast and slow reacting comparison of the movement in the price of an asset.
The most common times used in this case are 20, 50 and 200. The larger the period included, the less responsive the indicator becomes. In doing this, one is able to set up and use the Crossover Strategy which involves a faster time ‘crossing-over’ a slower time which can be indicative of change in trend in a given timeframe.
- Pros: They can also offer dynamic support and resistance lines. They also smooth out the price so that you can see a clear indication of direction.
- Cons: As they as based past data and therefore their response is delayed.
Exponential Moving Average (EMA)
The next Technical Indicator for Defensive Trading is the EMA. The EMA is a Moving Average Indicator which is similar to SMAs. It is a trend indicator expressed as a line chart to view the average of the closing price for a set period, on a continuous basis.
However, unlike SMAs, EMAs smooth out any one-time spikes caused by a price surge from a news release or similar event because they weight the most recent periods more heavily. Contrastingly, SMAs will give each time period equal weight. Again, common times are 20, 50 and 200 but remember that the larger the period included, the less responsive the indicator becomes.
- Pros: They can also offer dynamic support and resistance lines.
- Cons: EMAs can cause ‘fake’ indications as they can be too responsive.
Trading Tip: MAs are very useful when use in combination of 2 or 3 at one time. A combination of SMAs and EMAs may be used on the same timeframe, or a combination of either SMAs or EMAs on different time frames as indicated above. This will create the ‘Cross Over’ strategy.
Bollinger Bands
Probably the most favoured Technical Indicator for Defensive Trading is the Bollinger Bands indicator. Bollinger Bands are primarily a volatility measure, but they are so much more than that.
They are situated overlaying the main candlesticks of a chart and appears as a combination of line charts. It calculates price and volatility over a set period of time inclusive of standard deviations.
The lines represent a maximum and minimum moving average. They are very easy to read as during times of more volatility the wider the bands are apart when the indicator is said to be loud. Conversely, during periods of less volatility, the bands are closer together and are said to be quiet. These two occasions give the trader a good understanding of the sentiment of the market and it can be clearly seen when there is a period of consolidation, which is followed by a definitieve break out into a new trend albeit a continuation or a reversal.
- Pros: The various lines can be used to trade the Bollinger Bounce as they act as dynamic support and resistance lines. In addition, they are simple, reliable and don’t dazzle the eye too much to detract from the underlying price movements on the charts.
- Cons: Only a small piece of the puzzle, while knowing and understanding volumes is very helpful, you cannot rely on it alone.
Moving Average Convergence Divergence (MACD)
Another favourite Technical Indicators for Defensive Trading is the MACD. The MACD is a Momentum Indicator and is indicative of a trend. It is expressed as a line chart and a histogram. It is made up of 3 measures; a fast-moving average, a slower moving average and the difference between the two displayed as a histogram. The periods are normally, 12, 26 and 9. It is usually located below the main section of the chart and can often be similar to a sine wave formation, more often than not, it will not formally take this form.
- Pros: Only gives signal once the trend has been established so using this indicator will not be relied upon for getting in early.
- Cons: Can be quite delayed in its response such that the move may well have already commenced in terms of price movement when the MACD is not yet providing this signal. Notwithstanding, this being known means that it can be used accordingly.
Parabolic SAR (Stop And Reversal)
This Technical Indicator for Defensive Trading is an Oscillator. This means that it will oscillate between two set ranges around a central point. It is primarily used to signal the end of a trend and/or a reversal of a trend. This can be used to indicate an exit point for a currently running trade, or an entry point for an upcoming trade.
- Pros: Very easy to understand and use.
- Cons: As with many other indicators, it is best used in a trending market otherwise it can just give ‘fake’ indications.
Stochastic
The Stochastic is also an Oscillator indicator and can be used as a Technical Indicator for Defensive Trading. Used to signal the end of a trend, it is expressed as a line chart that measures if an asset is overbought or oversold. Made up of a faster and slower measure the Stochastic gives a reading in the range between 0 to 100, with over 80 being considered overbought territory, and under 20 being considered oversold territory. During a typical trend, it generally moves in an irregular sine curve formation.
- Pros: Creates a condition called divergence, which is a trade set up.
- Cons: Markets can linger in overbought or oversold territory for extended periods, during which time the price can continue to extend further in that direction giving the trader a conflicting situation to read.
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Relative Strength Index (RSI)
The RSI is an Oscillator which is best to signal the end of a trend. Displayed as a line chart and is similar to a stochastic in that it identifies overbought and oversold territory of an asset. However, while it also ranges from 0 to 100, distinctly, it uses levels of 70 and 30 to indicate overbought or oversold territory respectively.
- Pros: Creates a condition called divergence, which is a trade set up.
- Cons: Markets can linger in overbought or oversold territory for extended periods, during which time the price can continue to extend further in that direction.
What Is The Best Combination of Technical Indicators?
How you decide to trade is ultimately your own decision. After thoroughly reading and understanding the Defensive Trading approach to trading, you will be prepared to start to implement trading strategies that best suit your trading style and preferences.
However, as a general rule, it is not advised to have any more than 3 technical indicators active on your chart at any one time. This is because if you have any more, your eye and mind will be confused by the excess, and often conflicting information they are presenting causing you to doubt your decisions and make mistakes. Conversely, too few and you cannot have a second and third confirmation of your trade.
For a definitive list on which are the best indicators to use in combination with one another see the following list of indicators that have been discovered to work best together. Please note that in reality these have to be used in addition to spotting chart and candlestick patterns and understanding Fundamental Analysis:
- Bollinger Bands
- 200 period SMA or EMA (slow)
- Stochastic or RSI
- MACD
Should I Backtest Technical Indicators?
No matter what Technical Indicators you choose to use for Defensive Trading it is always essential to backtest the combination before applying them to a live trading scenario. As the name would suggest, backtesting is assessing a strategies effectiveness on long-term or recent historical data (charts) to see if it is something that can be relied upon during the current market conditions. This way you get to see where the correlated buy or sell signals have appeared, and the subsequent move of the asset, without actually risking any capital.
As with everything in Trading, there is expensive (and often unreliable) software that you can purchase to perform this task automatically, however, it is preferable, especially as beginner traders, to perform this manually. This way you will be learning all the while. In addition, the best thing about manual backtesting is that it can be done over the weekend while the markets are closed.
Which Are The Best Technical Indicators For Defensive Trading?
As mentioned, there is no easy answer to this question. However, there is also a huge amount of flexibility as to which combination works the best for you.
If you are unsure as to what you do prefer, the best approach to discovering it is to trade on a demo account so that you can test various combinations of analysis without risking any capital.
As always, if you have any questions, we would love to hear from you in the comments box below. Happy trading!
