Indicators

[Joe Ross]

If you are going to use indicators, then you had better known when they are telling you the truth and when they are not, as well as how or when to use them.

It is only fair that I elaborate on this subject. I do so for those of you who insist on using indicators. I have consistently written that if you are going to use an indicator, learn to understand what that indicator is telling you, as well as when you can believe it, and what it can or cannot do for you.

Let’s get one thing straight. I have no objection to the use of indicators as special purpose tools once you understand how the market works. From having taught hundreds, maybe thousands of students, I have come to the conclusion that perhaps one trader in a thousand actually knows and understands what is going on in the market. This includes professional traders with 10, 20, and 30 years of experience. I have been amazed at the number of professional floor traders who have come to me with 20 or more years of experience and who while making a good living in the markets, had no idea of how it really works. They have learned some winning ways, and have had the diligence and persistence to stick with those ways and it works for them. I can tell you one thing for certain, not one of them has used an indicator. In fact, the world of indicators is practically unknown to them. They have made their money by learning how to get an edge and exploit that edge. They are opportunistic traders. However, what they do is of little use to the rest of us who have trade from a screen. The insiders own the market. Their success at trading is a natural consequence of the fact that they have a built-in edge once they learn what it is and how to use it.

The truth about how markets actually function is something that can be learned, something I've been teaching for years. In deference to those who have paid good money for that information, I cannot reveal that information in detail by posting it publicly. However, once you learn how to truly view the price action, it will forever change the way you see the markets. Therefore, I will try to give you an overview so you can figure things out for yourself.

It is when you fully understand how markets work, it is then, and only then that you will understand how you might use an indicator to assist you in trading what you see.

With all of that said, let’s begin to look at indicators.

What are the best uses of an indicator?

• To confirm what you see
• To reveal something you cannot see
• To confirm the end of a trend
• To confirm a trend

In addition, please understand this: Any type of oscillating indicator is going to look as if it is working whenever a market is moving generally sideways. When a market begins to trend you can throw away all oscillating indicators—they are virtually worthless in a trend. They will not adequately tell you the truth.

Conversely, a moving average works in a trend, but fails miserable in a sideways market.

Why is this? Virtually all of the oscillating indicators available in the public domain are based on some form of detrending a moving average. It makes no difference how the moving average is computed. It can be simple, geometric, logarithmic, exponential, or weighted in some way. It can be based on one or more moving averages computed in entirely different ways. It doesn’t matter. The vital point to understand is that to create the oscillating indicator, you must remove the trend. How can anyone expect a detrended moving average to tell them the truth about price action in a trend when the trend has been taken out of the moving average in order to create the oscillating indicator?

Am I getting through to you?

Now let’s look at the other side of this situation. The moving average, regardless of how it is computed is the correct tool to use for confirmation of a trend. A moving average will trend when prices trend. But it will destroy you if you try to use it in a sideways market. Why? Because there in no trend in a sideways market. That’s why it is called “sideways.” That is why it is called “congestion,” “consolidation,” and “trading range.”

When thinking about using oscillators please notice a few things of interest.

1.) What if you are using Stochastics and arbitrarily set the indicator at 7,5,3. Had you set it at another value, you could have obtained a completely different result. Who is to say what is the correct setting for an indicator? Is the moving average to be set to the cycle for the underlying? How about setting it at the half-cycle? But why? Why not something else. Why not set it by curve fitting a moving average to that last known trend for this underlying? Do you see where I’m going with this? There is no sure way to decide on the settings for an oscillator. The setting you used last time may be totally inadequate for the market at it is proceeding this time.
2.) Some people think that “divergence” presents a good use for an indicator. Great, but how accurate is divergence? All too often when
an indicator shows what some believe to be divergence, prices continue to move the way they have been moving. This brings up the question of when can you believe the indicator and when can’t you believe the indicator?
3.) How often have you seen an indicator flash an “oversold” condition, and then watched prices continue moving down. Did the fact that the indicator flashed oversold prevent prices from continuing their relentless downtrend? Often not so! Prices can keep coming on down, with only a couple of minor corrections.
The point of all this is not to knock indicators, but rather to show you that if you are going to use them, you must know how and why they do what they do, and also be able to tell when they are indicating what is true and when what they indicate is false. Taking into consideration what was said previously, we can readily see that an oscillating indicator will work fairly well when prices are consolidating. The longer the period of consolidation the better.

Stochastics as well as most oscillators are momentum indicators and they reveal changes in the direction of momentum. However they are far from perfect in filtering out which trades are worth the risk of taking and which are not. Something else is required.

Many traders are tempted to use another indicator, but most of the indicators available, at least in the public domain, are themselves momentum indicators. ‘Momentum,’ RSI, DEMA, MACD, MACDH, %R, ADX, etc.
Using a momentum indicator to confirm another momentum doesn’t make much sense. Yet it is amazing how many traders believe that to be a valid way to trade.

What is needed is something faster than an oscillating indicator. That really leaves only one choice—the chart itself. Nothing is faster at showing price movement than a simple open, high, low, close bar chart.

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By the way, we offer a Free and valuable Trading Manual! If you are interested, please click here:
http://www.freetradingmanual.com

[SJR3tz]

You bring up some very intresting ideas up, but I don't know if they are easily answered. I would like to dicouse them with you and others here at money tec.

First of all I would like to bring up the idea of know what is going on for enlightment reasons, for myself. As I do not think this is an easy thing to have absaluts in. I do agree that it is better to know more then less, but what degree is hard one to answer. For practicle reasons and other reasons. How many of us use a microwave and know exactly what is going on. Or maybe a better example a car. Most people know that we need to put gas in a car and press pedals. For the most part that is what I know. But I have learned more as need to fix it on my own or help from family. When I need to fix a car I would like to know everything about it, but I do not feel it is practicle for me to go to school to fix my own car, so I learn as I go. But on the other side if it is how one winns his/her bread, I feel he/she should have a better understanding. Just as playing games, rules may seem they hinder you. But IMHO they protect you, and those who get good at games learn to use the rules in their benifit.

I think a good rule of thumb is, the more you depend on something the more you ought to understand it.

Indicators can not tell the futor. They are only mathatical formulas. Math does not know the futor. Science does use math to predict the futor of certian condition within cerntian degree of error.

I need to go now, but I would like to dicous this furthor.

Steven

[SJR3tz]

PS: I signed up for the ebook. Look forward to see how I like the ideas.

Steven

[TheSundanceKid]

Great "article"! You made a couple of important points regarding indicators that I think many people don't take into account when trading.
I have to say that I rely heavily on indicators, but I always wait for the price action to confirm what my indicators are telling me. Price will do what it wants, often times without regard to what an indicator is indicating it will do. I believe this is because the markets are primarily driven by fundamentals, not technicals. However, I also believe that will the right knowledge and analysis skills, one can use technical analysis to trade profitably and successfully. Indicators can describe, explain, and give clues as to where the market is going and what it is doing, but they cannot predict the future, and nothing is set in stone.

Thanks for sharing your thoughts, insight, and experience with us!

[4X4X]

Originally posted by Joe Ross
What is needed is something faster than an oscillating indicator. That really leaves only one choice—the chart itself. Nothing is faster at showing price movement than a simple open, high, low, close bar chart.
http://www.freetradingmanual.com

You have talked a great deal on the imperfection of INDICATORS, now can you tell me how one can find the strength of the trend using a bar/candlestick chart?

[TheSundanceKid]

You could Draw a Trend Line.
You could also use candle stick/bar formations (such as the hammer, and railroad tracks), and price patterns (such as head and shoulders pattern, bear flag, etc) however I almost never rely on those, with the exception of breakouts.
You could look at several charts with different time frames to get an "indication" of the trend and where the price is headed. (I do this often)
Don't forget classic support and resistance and fibonacci levels (both of which I like).
Then there are more exotic and eccentric methods, such as using Gann analysis, Elliot Wave patterns, Astra-Charting, counting bars/candles, etc, etc - none of which I have any confidence in, but I'm sure some people swear by them.
Those are all the ways I know of analyzing price action without using indicators. But then again I guess you could consider all of the ways I mentioned as "indicators", since you are using them to get an indication of where the price has gone and/or is going. I guess you could even say price charts themselves are an "indicator", if you really want to get..."technical"...LOL
Okay, Okay, that was corny.

[darmasdt]

Originally posted by Joe Ross
...What is needed is something faster than an oscillating indicator. That really leaves only one choice—the chart itself. Nothing is faster at showing price movement than a simple open, high, low, close bar chart...

Wow, thank you for posting this statement. When I was disappointed by all the standard and also custom indicators, then I realize, I still can trade by using only fibonacci, trendlines, chart and candle patterns. And the result is eve better than relying on indicators. But then I was in a thinking: am I on the correct path to find a successfull trading system for me? Because I've thrown away all my works on building custom indicators and expert advisors on Metatrader, and use plain charts on my screen.

But after you post this articles, that the price chart is faster than any (other) indicators, then I have this better grip on my head, to keep improving my skill on using the price chart itself.
I hope I'm correct

p.s.
I've subscribed to your free ebooks also.
Let's see how it will improve my journal

[TheSundanceKid]

I think the most important thing is just to make sure that you're comfortable, confident, and successful with whatever type of analysis you're using.

Sundance