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Research 2024-12-07 6 min read

Technical Indicator: Myth or Bust

Testing common technical indicators to separate fact from fiction.

Technical Indicator: Myth or Bust

We put common technical indicators to the test. Do they really give you an edge, or are they just "trading astrology"?

RSI Divergence Chart

The RSI Divergence

The Theory: When price makes a higher high, but the Relative Strength Index (RSI) makes a lower high, it signals waning momentum and an imminent reversal.

The Reality: In strong trending markets, divergence can persist for weeks while price continues to make new highs.

  • Win Rate: Our backtests show a win rate of only 48% for standalone RSI divergence strategies on the H1 timeframe.
  • The Trap: As shown in the chart above, a trader shorting the first divergence would have been stopped out as the trend accelerated. Divergence is often a sign of a pause, not necessarily a reversal.

The Golden Cross

The Theory: The 50-day Moving Average crossing above the 200-day Moving Average is a guaranteed long-term bullish signal.

The Reality: While it captures massive multi-year trends, it is a severely lagging indicator.

  • Lag: By the time the cross occurs, the market may have already rallied 20-30% from the bottom.
  • Whipsaws: In choppy sideways markets, the Golden Cross generates significant false signals, leading to "death by a thousand cuts" as you buy the top and sell the bottom of the range.

Bollinger Bands Squeeze

The Theory: When volatility contracts and the bands squeeze, a violent breakout is imminent.

The Reality: Confirmed. This is one of the few indicators that holds up statistically.

  • Volatility Cycling: Markets cycle between periods of low and high volatility. A squeeze accurately predicts that a move is coming.
  • Directional Ambiguity: The squeeze tells you something is about to happen, but it doesn't tell you which way. You need price action confirmation to pick the direction.

Conclusion

Technical indicators are tools, not crystal balls. They work best when:

  1. Combined: Use them in conjunction with price action and fundamental data.
  2. Contextualized: Understand the market regime (trending vs. ranging).
  3. Tested: Never trade a signal you haven't backtested yourself.