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Jan 2, 2008 - Keep it simple is a rule that works well in the markets...
Indicators have been around as long as technical analysis was invented. But with each passing year, the number of new indicators introduced hitting the market is astounding. Not only that, the latest technology is able to calculate complex formulas that even the most complex indicators serve well in real time. But what does one choose to test and use to create a successful robust strategy? A trader can spend an entire lifetime learning and combining all of them and still cannot come close to getting a decent result. Understanding how each indicator is formulated and verifying how they work and display in REAL TIME is the key. Many indicators look very good in historical charts, but they show ambiguous numbers when they come down to calculating with the bouncing prices live. There are two types of indicators: timing and trend. These should be viewed in this way to catch the basic essence of the market mechanics. If one looks at all the trading masters, almost all follow the trend of the market. This is one of the highest probability methods to get the big wins. The second element and probably the most important, is the timing of the entry and exit. Combining this with the right direction of the trend will complete the strategy. Timing indicators are normally called oscillators. They have a maximum limit and a minimum limit such as Stochastics, RSI, among others where the minimum is 0 and the maximum is usually 100.
The trend indicators have no upper or lower limits, from high positive maximum to low negative minimum, all depending on the prices and how far they go. These trend indicators are DMI, MACD to name a few. The idea behind a trend indicators is: always trade on the side of the trend. So the first step is to check the trend, which way the money is pushing the prices. Once that is established, look at the oscillator to time the entry. It was mentioned earlier that an indicators readings can be somewhat different when it’s not in real time and when they are. With historical charts, the readings seem to indicate a clear entry or exit signal, but in real time, it’s more ambiguous. Combining them together the chart begins to give better gauge of what the market is likely to do next, at least a better probability of when to stay out of the market.
In Figure 1, the chart shows the trend is rising (MACD moving upwards). If the trade was taken right now, it would more then likely not be prudent since the market has already moved and the trade is taken too late. Adding the oscillator will show exactly that, the Stochastics is overbought, which means the market is currently exhausted (at 80 and above) and there may not be more buying until some steam is let off (by moving back to the oversold near 0-20 reading). So by using these two together, the market action becomes more visible. Let’s take another example.
The chart above shows a Bollinger Bands overlaid on the price chart. Bollinger Bands (volatility bands) shows the extremes of price movements, normally set to 2 standard deviations (upper line, lower line from the center moving average). One way of using them is when price moves and touchs the upper line, prices are predicted to reverse and move down and vice versa. Combining this with DMI, we will know whether there is a trend or not or which direction the trend is going. Currently the chart shows the DMI lines are converging, indicating there is no trend or that the market is going sideways. This is the beauty combining indicators: it helps to keep you out of the market when things aren't looking to hot. Keep it simple is a rule that works well in the markets. Combining the two common indicators can be effective. Do more research and make sure to test in the real time to get an idea of how the indicators work to avoid confusion and indecision.
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Disclaimer: Please note that charts and commentary provided by the moderator are for educational purposes only. Any trades placed upon reliance on the moderator’s charts or information is taken at your own risk for your own account. Past performance is no guarantee of future results. While there is great potential for reward trading stocks, futures and options, there is also substantial risk of loss and you must decide your own suitability to trade. Future trading results can never be guaranteed. This is not an offer to buy or sell stock, futures, options or commodity interests. Most trading systems are based on historical formulas which have worked in the past. However, what has happened before may or may not happen again. You can lose all your money trading stocks, futures, and options and you must decide your own suitability as to whether or not to trade. Only trade with true risk capital you can afford to lose. Only trade markets you can properly afford to trade. Properly funded trading accounts typically perform better than those that are not. Never risk more than 2-3% of your account on any one trade. Always define your risk before entering a trade and place a stop to limit your risk. There are no guarantees or certainties in trading. Trading involves hard work, risk, discipline and the ability to follow rules and trade through any tough periods during a system’s draw downs. If you are looking for a guarantee, trading is probably not for you. Most people lose money trading. One of the reasons is that they lack discipline and are unable to be consistent. A system can help you become consistent. Ironically, worrying about the monetary aspect of trading can contribute to and cause a trader to make trading errors. Therefore, it is important to only trade with true risk capital.
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