By Sam Seiden, Online Trading Academy Instructor
One of my favorite John Candy movies of all time. When I was a teenager, I was an extra in another one of his movies and got to meet him, big funny guy just like I expected. As funny as the movie is, there is a real story in it that all traders need to be aware of. I go through periods where I travel quite a bit. Air travel can be draining because air travel means airports. Being an Executive Platinum member, knowing all the short cuts and tricks with lines and special seating, I still find the experience long and draining at times. Once you're airborne, however, there is little to complain about. Just sit back, relax, and reach your destination. Driving to your destination is another story. Long airport lines are often replaced by stand still traffic. You are also now the pilot so there is much more responsibility than flying. However, heated seats and a good sound system make driving a pleasure these days. Train travel is something I have not experienced much. My limited experience left me with the perception that it's long (which is fine if you're ok with that), relaxing, and you get to see plenty of nature. Whether your destination is Florida or the North Pole, a plane, train or automobile can get you there.
Just like travel, there are many ways to reach your desired destination in trading. The chart below shows a recent swing trade from the Extended Learning Track (XLT) - Futures class. The supply level was well-placed on the curve (this is a daily chart). Our "odds enhancers" exercise suggested this was a high probability opportunity, as well. When price rallied up to our supply level for a short entry, it actually gapped into the level which made the shorting opportunity very ideal as the gap told us these were very novice buyers. Price proceeded to fall to our target and the trade was complete. When I went over this opportunity with XLT members, I used the chart you see here which has only price and volume on it. All the information we needed to identify and take advantage of this low risk and high reward opportunity is clearly seen with price and price alone.
Figure 1 Some traders, however, are either not comfortable using only price action analysis or they desire more confirmation to take a trade. For this, people tend to use indicators and oscillators as the confirmation crutch. Let's take a look at the same trading opportunity only this time, let's add Bollinger Bands.
Figure 2 At the time of entry for our short position, we see that price has actually pierced the upper Bollinger Band suggesting an overbought condition for the Ten Year Note on the daily chart. Price piercing the upper band and reaching an objective supply level with a large profit margin below, this suggests higher odds. Adding Bollinger Bands to this trading opportunity makes the trade more attractive and also points out a key ingredient when using Bollinger Bands. Don't just sell short because price is piercing an upper or lower band. Take action because price is piercing an upper or lower band AND price has reached a supply or demand level. In the Options XLT, for example, our options expert Eric Ochotnicki calls this setup an "All Star" setup.
Figure 3 Let's again look at the same shorting opportunity and add the Commodity Channel Index (CCI). This is an overbought (+100 or greater)/oversold (-100 or greater) oscillator. Notice at the time of our short entry, CCI was giving an overbought reading again, suggesting this was a high odds opportunity to sell short. Notice the overbought CCI reading I circled. This is in line with our short entry which makes CCI look attractive as a decision-making tool. However, look just to the left of that circle and you will see other overbought readings and price didn't turn lower. The reason is because price does not turn lower because CCI is overbought; it turns lower because it has reached a price level where supply exceeds demand. As for using it for confirmation, it's a decent secondary decision-making tool. The second red circle shows CCI oversold which lined up well with our profit target for this trade. Again, are we taking profits because CCI is oversold? Look just to the left of that circle; there are other oversold readings but price didn't stop falling. Price stopped falling because it reached our target which was a demand level. If CCI was our primary decision-making tool here for entry and exit, we would have entered the trade early and likely stopped out for a loss and we also would have taken profits way too early.
Figure 4 Last but not least, let's add Slow Stochastics to our successful Ten Year Note trade. Stochastics are a very popular overbought/oversold oscillator. The typical buy and sell signal are a moving average (red and blue lines) cross in overbought and oversold territory. Did the Stochastics sell signal line up with our price action sell signal? Yes. Did the Stochastics buy signal line up with our price action profit target demand level? Yes. Did we need Stochastics for this trading opportunity? No.
The most important point here is that while indicators and oscillators can assist in one's "comfort" level, these can't be used as primary decision-making tools. These tools don't know anything about supply and demand. It's not that they are broken or don't work. They are mathematical-generated lines on your chart. The math is always correct. Whether that math leads to profits or losses in your trading account is the question most novice traders never ask and it happens to be the only question that matters. As John Candy showed us, there are many ways to reach our destination. Trading is only slightly different. While you can use indicators and oscillators as confirmation tools, if you are NOT filtering these buy and sell signals through real demand and supply levels, you are traveling east and west, trying to reach the North Pole; good luck with that. If you must use indicators and oscillators, go ahead and use them. Again, just make sure you filter those signals they spit out through proper supply and demand analysis. If I just repeated myself three times, it's only because it's so important and we at Online Trading Academy care about you and your financial well-being.
Have a great day.
- Sam Seiden sseiden@tradingacademy.com
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