Look To Your Left!
Most people who trade these days use indicators or oscillators in one way or another, searching for the magic input values to make them work consistently. After losing money and spending countless hours in this effort, they realize that there is no magic set of inputs. While it may seem like I beat up lagging indicators and oscillators often, the truth is that they are terrific, when used properly. One of the best things about Online Trading Academy is that in our classes, we don't show examples of indicator and oscillator setups that only work. We say over and over that these are fine supporting tools but they are not to be used as buy and sell signals alone. Why would we even teach them at Online Trading Academy then? Simply, we know that students will be exposed to them in other courses and books that typically only show perfect indicator setups and it is our job to enlighten them on the realities and limitations of these tools.
Here we have a chart with the Stochastic oscillator plotted below price. Typically, when the fast line crosses over the slow line in oversold territory (circled areas on the chart), this is a buy signal that people are taught to take. If you take each and every one of these signals in any market, you will likely have many more losing trades than winners. Why is there no magic set of inputs for the indicators or oscillators? The reason for this is simple… What no indicator or oscillator takes into account is the dynamic supply and demand relationship which is responsible for the movement of price in any market at any time.
Area "A" in the chart above represents temporary price stability which gives the appearance of supply and demand equilibrium. The advance in price from "A" tells us that area "A" was really a price level where demand greatly exceeded supply. The initial advance from that level can only happen because of a supply and demand imbalance at price level "A". In other words, there were many more willing buyers than sellers at level "A". Therefore, if and when price revisits price level "A" for the first time - see area "B" - we can say that price is revisiting a level where demand greatly exceeds supply at "B". In any market, when price is at a level where demand greatly exceeds supply, prices advance. "B" is the low risk/high reward time to buy. Notice that the stochastic gives us a nice buy signal at that time which is one we would pay attention to.
The two buy signals to the right that come later don't coincide with price revisiting an objective demand level. These stochastic buy signals are to be ignored. The key to using an indicator or oscillator, stochastics in this case, as a mechanical buy and/or sell signal is to only take the buy signals when price is at an objective demand level. When it is not and the stochastic gives you the buy signal, most of the time it is best to ignore the signal.
Incorporating this into your trading will likely eliminate many losing trades and keep the winners. Wrapping true supply (resistance) and demand (support) around any and all facets of your trading can only lead to lower risk and higher reward trading. The next time your indicator gives you a buy or sell signal and you are wondering if there is support or resistance at that level, simply "look to your left" and the chart will give you all the information you need.
Have a great day.
- Sam Seiden, sseiden@tradingacademy.com
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Sam brings over 15 years experience of equities and futures trading which began when he was on the floor of the Chicago Mercantile Exchange. He has traded equities, futures, interest rate markets, forex, options, and commodities for his personal interests for years and has educated hundreds of traders and investors through seminars and daily advisory services both domestically and internationally. Sam has been involved in the markets since 1991 both on and off the floor of the Chicago Mercantile Exchange. He has served as the Director of Technical Research for two trading firms and regularly contributes articles to industry publications. Sam is known for his trading, technical research, and educational guidance.