Just What You Need
Developing Your Own Indicators
by Lee Leibfarth
Does the thought of developing custom indicators intimidate you? It doesn't have to. Here's a step-by-step look at the process.
Custom indicators can give you a perspective on market conditions that you can't get yet by simply reading a price chart. Custom indicators allow you to quickly check the validity of trading ideas specifically in the way you want to, and they can be an important visual tool to assist in everyday trading. Developing custom indicators doesn't have to be rocket science, even for traders unfamiliar with programming.
I will discuss the development of three different technical indicators along with some of their potential uses. Although the examples will be illustrated using TradeStation EasyLanguage, the concepts can be easily applied to almost any charting platform that allows the programming of custom indicators such as eSignal, MetaStock, Wealth-Lab, and others.
Before we jump into the indicator developer arena, we must understand the concepts behind some of the more popular indicators. For the sake of this article, only stand-alone indicators will be discussed: those that are displayed in their own charts, usually just below a price chart.
Most technical indicators are based on price action over a given amount of time (or lookback period) and use some type of mathematical calculation or formula to determine its values. Most commonly available indicators, such as moving averages, moving average convergence/divergence (MACD), stochastics, and commodity channel index (CCI), allow for an element of customizing simply by changing their input variables. Input variables are user-defined values (such as lookback period or price data) that modify the behavior of the indicator. Changing input variables does not require any additional programming, but can give the indicator different values and point out unique market conditions.
In addition to price data calculations, many indicators use some form of smoothing. Smoothing usually means taking a short-period moving average (three-to seven-period) of a choppy indicator in order to create a version that filters out some of the noise. The smoothed version of an indicator is often projected over the original. This allows for potential trade signals as the original indicator crosses above or below the smoothed version. Indicators such as the stochastic and the MACD make use of smoothing.
Indicators may also be normalized, so that instead of having the indicator value being relative to the individual price of an instrument, it can be read on a percentage or fixed scale. Normalization can be a great advantage when comparing different markets, as it allows common thresholds to be established representing areas of interest such as overbought or oversold regions. Stochastics and CCI represent indicators that are normalized and oscillate between a predefined range.
Custom indicators can take many forms and include those that compare different data functions, those that look for a unique condition in the market, and those that combine several different conditions to create trading signals.
...Continued in the January 2006 issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the January 2006 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2005, Technical Analysis, Inc.
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