By Sam Seiden, Online Trading Academy Director of Online Education
When walking around an Online Trading Academy classroom during the trading portion of a Professional Trader class, I see the trading work–spaces of traders, the charts they are looking at and most importantly, what lines, circles, indicators, and oscillators are on those charts. This last part is most important because what you add to a raw price chart will likely strongly influence your trading decision. After all, why else would someone add something to a chart? The biggest issue I see in the classroom relates to indicators and oscillators. These are fine tools that can work very well for you if you use them correctly. However, many people attempt to take short cuts and use them incorrectly. In this piece, I want to take this issue back to basics and remind you of what really makes a market move and an indicator work.
Moving Averages
Figure 1 This recent trading example is found on a weekly chart of the S&P (SPY). This is the short setup I suggested in the April 27th, Lessons from the Pros article, Where is the Stock Market Going? The opportunity was to either take profits on a long position, or sell short when the S&P reached the supply level I planned out on the 27th. The question that becomes the issue is this: What is the definition of supply to you? For many, price resistance (supply) is the moving average. I can't tell you how many times I see people wanting to buy or sell a stock because it is rising or declining into a moving average. The moving average itself is price resistance for them. In the example above, price does stop rising and turns lower right at the moving average, but that's not really why it turns there. It stops rallying and turns lower because there is actual price resistance at that level. In this case, the moving average happens to line up with that price supply, but this is not always the case. In fact, much of the time, the moving average does not line up with real price resistance (or support). What happens to the new trader who fails to learn to identify real price support (demand) and resistance (supply) is that examples like this reinforce something that is simply incorrect. If I did not draw in the support zone on this chart and wrote an article about the power of ONLY using moving averages and showed this example, new traders would think moving averages, by themselves, serve as real market turning points. It is easy for this illusion to become your reality. You will only know it's an illusion when your trading account draws down so much that you begin asking yourself how and why markets really move and turn. It all comes down to proper supply and demand analysis. The thought that the moving average has anything to do with the turn in price is completely not correct. While this may fly in the face of conventional thought; every bone in my body tells me I am right, not to mention years of trading experience.
This is not to say that indicators and oscillators don't work or that we should not use them. The key point here is that we want to use them in conjunction with real price support and resistance. Indicators and oscillators are fine confirmation tools when used in the appropriate areas.
Bollinger Bands
Figure 2 Here we have a chart with Bollinger Bands on it. In theory, when price pierces the upper or lower band, it should revert back to the mid-line. In real world trading, which is what we practice in the Extended Learning Track (XLT) program, the chances of price turning after piercing the Bollinger Band are greatest when you also have price support or resistance. In the example above, price pierces the upper band and continues higher until it reaches price resistance (supply). It turns lower at price resistance for a low risk short entry. Again, it's not that we don't want to use the Bollinger Band, it's that we don't want to just use it in and of itself. Your trading can be so much lower risk, higher probability, and higher reward if you incorporate real support (demand) and resistance (supply) into your analysis.
Fibonacci Retracement Lines
Figure 3 On this intra-day chart, after the move higher in price, astute traders would look to buy on a decline in price to price support, but again, what is your definition of support...? For the trader who uses Fibonacci retracement lines solely as support for example, they have a choice of five different lines to choose from as prices decline. For the trader who incorporates real support (demand) analysis into their Fibonacci analysis, they would likely choose the 50% retracement line as that is the level that lines up with real price support. Again, to think that price turns higher because of a Fibonacci retracement level is completely the wrong line of thinking.
While I could use example after example, I think you get the point. Trading is competition at its finest. When you push the button to buy or sell, there is someone on the other side of your trade or investment hoping to take your money from you. Who will end up getting paid in that trade depends on who has analyzed the market based on objective information and truly quantified supply and demand. The goal is to attain an edge greater than your competition. Around each corner is another trader getting smarter, another Bernie Madoff, and another market maker or stock broker trying to sell you something for a price that they know is too high. Those that attain the needed edge in market speculation will get paid from those who don't. That's life.
Lastly, please don't ever take my strong language as anything other than concern for you and your finances. I am actually a very reserved and quiet guy who simply cares about people.
Have a great day.
- Sam Seiden sseiden@tradingacademy.com
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