Indicators Vs. Price Data

[PristineTrading 10]

have an announcement to make. I'm happy to report that the never-ending search for that perfect indicator is alive and well. It has never ceased to amaze me how people can take epic journeys towards attaining such mythical tools. They spend countless hours and money in the pursuit of that perfect tool that will provide perfect buy and sell signals, no matter what stocks and market conditions they're dealing with.

 

Let me state here and now that I have no prejudices against indicators. But in my journey as a trader (and many of you might agree with this), I've not been able to find any formula that can successfully produce buy and sell signals of quality, every single time in all market situations. But that's all right. Indicators aren't supposed to do that. In fact, it's our opinion, and that of many others I've had the pleasure to work with through the years, that the real purpose of indicators isn't that of providing reliable buy and sell signals. For that we have price patterns. Indicators (at least some of them) serve us well as "guides" that help us accelerate the analysis of a security's price behavior. Let's review this with an example.

 

One of the most archaic uses of indicators I can remember occurs when someone looks at crossovers on moving averages as buy and sell signals. I would bet countless individuals have paid thousands of dollars for "trading systems" that exclusively use this concept. Any trader with some knowledge of the way moving averages work would instantly recognize that by the time such moving averages "crossover", the price action has already occurred. In some instances, such signals might provide a continuation of momentum, but in general, by the time you get the signal, it's too late. That's the typical use of an indicator as a "price predictor". We're not in this business looking to predict. Our goal is to analyze opportunities, evaluate odds, and manage our trades. For us, a better and more objective use of moving averages is as trend following tools. Looking at a stock that presents a rising 20ma will quickly give us information about the trend of that stock, without having to look at 12 months of price data. Then, we will use price data to find reliable opportunities for trading.

 

So, the next time you look at a chart that includes your favorite indicator, try to use the information provided by it in such a way that helps you to evaluate the securities trend, strength, volatility and velocity. Don't try to use it to predict prices. In this way, you're bringing a level of objectivity to your trading that will serve you well through the years.

 

KURT CAPRA

Contributing Editor

Instructor and Traders Coach

[BlueHorseshoe 10]

 

One of the most archaic uses of indicators I can remember occurs when someone looks at crossovers on moving averages as buy and sell signals. I would bet countless individuals have paid thousands of dollars for "trading systems" that exclusively use this concept. Any trader with some knowledge of the way moving averages work would instantly recognize that by the time such moving averages "crossover", the price action has already occurred.

 

Yes . . . and no . . .

 

By the time such moving averages cross over, some price action has ocurred (enough to cause the cross). It doesn't mean that more price action isn't going to occur.

 

If a twenty day move has unfolded by the time of the cross, and you're looking to exploit twenty day moves, then the signal is too late; if you're looking to exploit two hundred day moves then it may be just fine.

 

And the "it fails more often than it works" argument is not valid - as long as you make more on the samll number of occasions when it works, and lose little on the majority when it fails, then you'll be net profitable.

 

BlueHorseshoe