Effective indicator combos that can help reduce false signals

TA uses technical indicators and chart patterns. Technical indicators are mathematical calculations based on the price and/or volume of a stock that help traders identify potential trade opportunities . Chart patterns are unique formations within a price chart used by technical analysts in stock trading. Chart patterns are not technical indicators. So I will just discuss technical indicators.

There are 4 types of technical indicators: trend, momentum, volatility and volume. Don't just use one type of indicator as shown in Fig. 1.

Fig. 1. RSI divergence.

From Aug 2021 to Sep 2021, $Frencken(E28.SG)$ was in an uptrend with the MA5 rising. A buy signal was generated. However, the RSI was showing divergence with it falling. The momentum was already waning. Indeed, the MA5 started falling in Sep. So the buy signal was false. At least 2 indicators should be used for verification.

It is better to not use more than 1 of the same type together to avoid redundancy. For example, don't use 2 or more momentum indicators. The results create redundant signals that can be misleading. It can make other variables appear less important and can make it difficult to accurately evaluate market conditions. Instead, apply different types of indicators together.

Indicator combos

The best results can be obtained using a combination of 2-3 indicators.

Fig. 2 Top Glove.

Fig. 2 shows the chart for $Top Glove(BVA.SG)$ . When there was a bullish MACD crossover, the price reversed to an uptrend. When there was a bearish MACD crossover, the price reversed to a downtrend. In Mar 2023, there was a bullish MACD crossover and the price rose until it reached the resistance level at 0.315. Then it consolidated until it was near the MA20 which was the dynamic support. It continued its uptrend when the MA20 crossed above the MA50 until it reached the resistance level around 0.35. It reversed to a downtrend when there was a bearish crossover until it hit the MA50 which was the dynamic support.

False breaks

Fig. 3. LS 2.

In May 2023, $LS 2 Holdings(ENV.SG)$ was grossly oversold with RSI around 10. Then there was a bullish MACD crossover and the price surged until it was near the resistance level of 0.168 and the MA100 (dynamic resistance). The MACD then turned downwards and it went into a downtrend.

False breaks also give false signals. Fig. 3 showed three false breaks. A break that failed to continue beyond a resistance level or a trendline is called a false breakout. And a break that failed to continue beyond a support level or a trendline is a false breakdown.

A false break of a level can be thought of as a 'deception' by the market, because it looks like the price will break out but then it quickly reverses, deceiving all those who took the 'bait' of the breakout. A false breakout is essentially a 'contrarian' move in the market that 'flushed' out those 'weak hands' who may have entered on emotion, rather than logic and forward thinking.

False break patterns are one of the most important price action trading patterns, because a false break is often a strong indication that price might be changing direction or that a trend might be resuming soon.

There are 2 types of false breaks - small and large. A small false break has a short wick and body while a large false break has a long wick and body.

The easiest way to identify a false breakout is to look at its closing price which will be below the resistance level. Sell the stock if it occurs. A false breakdown happens if the price closed above the support level. Buy the stock. Sometimes the false break may last a few days.

In Dec 2022, LS 2 was in an uptrend and broke out of the resistance at 0.26. It reached an intraday high of 0.275, but closed below the resistance. Subsequently, it reversed and went into a downtrend. So the breakout was a false breakout.

Summary

To reduce false signals, it's best to use a combo of 2-3 indicators. There is no need to use too many indicators, especially if they are of the same type as they will cause redundancy.

False breaks also give false signals. Learning how to identify them will enable you to trade more effectively.

TA has helped me to to identify support and resistance levels to buy and sell. Technical indicators enabled me to trade effectively and make profitable trades. TA can be used for all types of securities: stocks, ETFs, forex, cryptocurrencies, commodities, indices and so on. It can be used for stocks from any country.