When you are just starting to take baby steps in trading, usually the first thing you are concerned about is what are the best day trading indicators and chart configuration you should use. Wouldn’t you agree?
Well, you should modify the question slightly and try to find what day trading indicators are best for you.
As you would probably agree that we are all different, have a different psychological make up, and have different expectations from day trading. Because of that diversity, we all should try to find the best indicators for day trading that suit our own personality and how we trade, instead of simply mimicking another successful day traders and their trading set ups. Otherwise, we will end up losing money in the market faster than how the New York Mets lost their games in 1962!
Let’s have a quick discussion about how you can find the best indicators for day trading and pick a day trading charting software that will help make your life a bit easier during the trading day.
In order to build or develop your charts for technical analysis, you need to mainly decide about three components: (1) the right time frame, (2) the right on-chart indicators, and (3) a set of the right off-chart indicators.
Picking the Right Chart Time Frame
Do you think all indicators are created equal? No, but more importantly, not all indicators work the same way on all time frames. For example, lagging indicators like moving averages work best when there is less volatility. You would benefit highly from using a long period moving average on a daily chart compared to using the same configuration in a 5-minute chart of your favorite day trading chart software.
However, we do not want to impose any hard rules and convey the wrong message that there is any best time frame to day trade. You may have a higher patience threshold and prefer to use 15-minute charts, and I might have a lower patience threshold and prefer the 5-minute time frame.
While there are no hard-and-fast rules about which time frame you should use in day trading, you should consider a few things to make up your mind about picking the best time frame for yourself.
The first you should make up your mind when starting day trading is this: how much time would you devote to trading during the day? If you have a day job, you probably do not have much time to begin with and would likely spend only a few hours in front of the screen. On the other hand, if you are self-employed or run a small business, you will probably have a lot of free time to trade during the day.
So, the rule of thumb is that you should use a lower time frame when you would spend less time day trading. Similarly, you should use a higher time frame when you would be keeping an eye on the market throughout the trading day.
This is because when you are spending only a few hours in day trading, a 15-minute chart will only generate a few handfuls of bars and your day trading charting software, with all its advanced technical indicators, will have a hard time generating a proper signal with the limited data.
Instead, if you use a smaller time frame like the 5-minute chart, your day trading charting software will have the opportunity to analyze a lot of price data from enough bars and would be able to tell you which way the market is moving during that short period of time.
Moreover, when you are trading 8 hours a day and looking at lower time frames, you will have to analyze a lot of potential trading setups. As the number of trades goes up, as a human being, wouldn’t you feel tired of making so many decisions in a single day? The more you would trade, it is more likely that you will end up making more mistakes and give back the profits to the market.
If you are still not convinced, let me give you another reason to stick to the rule of thumb we just discussed. Your broker makes their profit by charging you commissions and from spreads. If you make 100 trades during the day and only end up making a few cents of profits on each of them, you are effectively paying a fortune to your broker in fees.
Do not end up working for your broker, take the time to analyze a trade properly, keep the number of trades low, and be a day trader – not a scalper.
Using On-Chart Indicators for Technical Analysis
If you add a ton of different indicators, it may look terrific or ugly, depending on the colors – of course, but you will probably find it difficult to interpret all the different data at once. You do know that all technical indicators are based on calculating the price data, right?
Hence, taking a “less is more” approach would not only help you declutter your chart, but also make it much easier for you to interpret the on-chart indicators on your chart.
Personally, I strongly recommend that you keep the Volume indicator on your chart at all times. The volume is a secular on-chart indicator, it does not tell you which way the price would go. But, it will tell you if there are ample transactions in the market and whether the bigger players are involved when the price approaches a key breakout level.
In addition to the Volume indicator, I always keep the 10-period simple moving average (SMA) indicator on the chart. The 10-period moving average is one of the most popular indicators among day traders. It is fast enough to give an early indication and direction of a significant price move, but not too slow like the 20-period moving average that I would leave a large chunk of the profits on the table when the trend ends, or worse, reverses.
Besides these two EMAs, you would also find the Average True Range (ATR) indicator sitting at the bottom of my day trading charts. Because the ATR value gives you the accurate representation of the volatility based on the actual price of the stock and forces you to assess each stock on a case-by-case basis. Would you really think the volatility of Microsoft and Tesla would be the same if they had the same ATR reading?
You can also use a few other derivative indicators to know about the important support & resistance levels. For example, I have a plug-in which automatically plots the pivot points used by floor traders, and I draw the Fibonacci levels of important price swings manually.
Using Off-Chart Indicators in Day Trading
While you would find the on-chart indicators to be essential for technical analysis, at the end of the day, charts and indicators are just sugar coated versions of the order flows that makes up the overall supply & demand in the market.
If you were a retailer, selling fruits, would you prefer to buy your stock from the wholesalers or the farmers themselves? Where would you get the best price? Of course, from the farmers.
In this analogy, if you would get the wholesale information about the market from technical indicators, you would get the best data from the Level II quotes. These quotes are the actual pending orders that other traders have placed with their brokers.
When traders place market orders to match these pending orders, these get filled. So, if you know that there are a lot of large pending buy orders below the current market price compared to sell orders, you can easily figure it out that if the support levels on your chart would hold the price or it would break below! Interesting right? You can explore about Level II here.
When it comes to day trading, I also heavily depend on another off-chart indicator – the Time & Sales data. Tradingsim offers this data in the “Time & Sales Window,” which represents the traditional “Tape.” By combining the volume and tape data, you easily get a “feel” of the market. Watching the detailed information regarding the order flow on the “Time and Sales Window” and depth of the pending orders in the Level II window of a particular stock can really take your day trading skills to a new level.
Success in day trading often boils down to the personality of the trader compared to how advanced the trading system he or she is using. That’s why, we always suggest that you keep things as simple as possible and focus on a few important indicators.
If you want, you can use a multi-screen trading setup and keep Tick Data, the spread between the S&P futures and the cash market, support & resistance, and Fibonacci levels of major stock indices like the S&P 500, etc. in a separate monitor.
However, always remember that the more information you have on the screen, the more time and energy it would require to analyze and process them. If you follow the advice given here and successfully match the right time frame, on-chart technical indicators, and tie the system with off-chart indicators, you would have a much better chance of becoming a successful day trader.