Price verses indicators
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One of the very first ‘holy grails’ of trading we encounter is indicators. When we first analyze them whilst looking at past charts, their accuracy looks impressive. But in a live trading environment, are they as useful as they look when we first learnt them with the benefit of perfect 20/20 hindsight?
What a new investor or trader does is to put too much reliance in them, only to find they give false signals. Alternatively, using a number of indicators together produces a situation where some are giving sell signals and others are screaming buy!
Am I therefore saying that indicators are useless? I don’t want to rattle too many feathers here, but it is good to ask questions with regards to the validity of the countless numbers of indicators we use.
All indicators have one thing in common. They use different types of price and volume action in order for them to be compiled. So the next logical question must be; can we simply look at price action as our means to enter and exit our trades?
Whereas many individuals will use indicators to tell them if we are in a strong market, surely price alone can tell us this? To give you an example, take a look at a chart of the Dow. Just looking at the rally in early March, I can see it performed this in the space of 9 traded days. However, the following retracement took 18 days to complete. It’s telling us the bulls have the upper hand as they can push the market up far quicker than the bears can take it back down again.
This type of price action can be viewed on any timeframe, whether it’s a daily, weekly, monthly chart or even an intra-day 5 minute chart. You can also use price bars themselves to give you a good measure of what is happening in the market and identify entry points.
For instance, if price has just broken out of a prior resistance area, I would be more inclined to wait for a pullback before entering the trade. If price pulls back to the area of previous resistance and bounces off it, that gives me a far better area to enter a trade. I can have better placement of my stop/loss and have better certainty that a new support area has been created.
Ok, so using price, whether it is by recognizing patterns, using candlesticks for analyzing opening and closing prices or using simple price reversal signals, we can certainly trade based on that alone.
However, for the number of competent traders I know who do not use indicators, there are others who swear by them.
One trader I know has so many indicators on his screen, it simply looks like one colourful mess of lines on his charts—but the key thing is that it works for him. One indicator he uses is a very short term RSI (2,2) in order to help identify when a pullback is completing on a stock or index that is in a larger uptrend.
Another trader I know likes to use MACD (12,26,9) showing it represented as both a line and histogram. He accompanies this with a stochastic (14,3,3) and combines the two.
Personally, I don’t use these indicators but as we all know, there is no definitive right or wrong way to technically trade. Although I look for price patterns frequently, I personally like to look at how price is moving in relation to key moving averages such as the 50,200 and 500dma. When I see price reacting in certain ways against these averages, it can help give me key buy and sell signals (see past issues).
In summary, you have to find a way of trading that suits you as an individual. The basic way of using indicators may require adapting these days, but they still have their merits if you want to use them to confirm price action.
But the leading indicator of all is price, so recognizing price reversal patterns, consolidations and continuations is essential. Once you have learnt how to spot them, then you need to know how to trade them. Remember, if you are seeing a chart pattern, it’s likely a lot of other traders are too. Because of that, I would
rather wait until after the breakout and inevitable pullback before getting into that
stock……
Regards Darren Winters
www.wininvesting.com and www.wininvestingnews.com
One of the very first ‘holy grails’ of trading we encounter is indicators. When we first analyze them whilst looking at past charts, their accuracy looks impressive. But in a live trading environment, are they as useful as they look when we first learnt them with the benefit of perfect 20/20 hindsight?
What a new investor or trader does is to put too much reliance in them, only to find they give false signals. Alternatively, using a number of indicators together produces a situation where some are giving sell signals and others are screaming buy!
Am I therefore saying that indicators are useless? I don’t want to rattle too many feathers here, but it is good to ask questions with regards to the validity of the countless numbers of indicators we use.
All indicators have one thing in common. They use different types of price and volume action in order for them to be compiled. So the next logical question must be; can we simply look at price action as our means to enter and exit our trades?
Whereas many individuals will use indicators to tell them if we are in a strong market, surely price alone can tell us this? To give you an example, take a look at a chart of the Dow. Just looking at the rally in early March, I can see it performed this in the space of 9 traded days. However, the following retracement took 18 days to complete. It’s telling us the bulls have the upper hand as they can push the market up far quicker than the bears can take it back down again.
This type of price action can be viewed on any timeframe, whether it’s a daily, weekly, monthly chart or even an intra-day 5 minute chart. You can also use price bars themselves to give you a good measure of what is happening in the market and identify entry points.
For instance, if price has just broken out of a prior resistance area, I would be more inclined to wait for a pullback before entering the trade. If price pulls back to the area of previous resistance and bounces off it, that gives me a far better area to enter a trade. I can have better placement of my stop/loss and have better certainty that a new support area has been created.
Ok, so using price, whether it is by recognizing patterns, using candlesticks for analyzing opening and closing prices or using simple price reversal signals, we can certainly trade based on that alone.
However, for the number of competent traders I know who do not use indicators, there are others who swear by them.
One trader I know has so many indicators on his screen, it simply looks like one colourful mess of lines on his charts—but the key thing is that it works for him. One indicator he uses is a very short term RSI (2,2) in order to help identify when a pullback is completing on a stock or index that is in a larger uptrend.
Another trader I know likes to use MACD (12,26,9) showing it represented as both a line and histogram. He accompanies this with a stochastic (14,3,3) and combines the two.
Personally, I don’t use these indicators but as we all know, there is no definitive right or wrong way to technically trade. Although I look for price patterns frequently, I personally like to look at how price is moving in relation to key moving averages such as the 50,200 and 500dma. When I see price reacting in certain ways against these averages, it can help give me key buy and sell signals (see past issues).
In summary, you have to find a way of trading that suits you as an individual. The basic way of using indicators may require adapting these days, but they still have their merits if you want to use them to confirm price action.
But the leading indicator of all is price, so recognizing price reversal patterns, consolidations and continuations is essential. Once you have learnt how to spot them, then you need to know how to trade them. Remember, if you are seeing a chart pattern, it’s likely a lot of other traders are too. Because of that, I would
rather wait until after the breakout and inevitable pullback before getting into that
stock……
Regards Darren Winters
posted by Darren Winters at 2:12 PM
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