Indicators And Oscillators Are Wonderful If You Use Them Properly
Most active traders use indicators. I use them as well in one of the strategies I employ. While many people including myself have often beat up the indicators, they are actually a great tool when used properly. The problem is that people tend to take every buy and sell signal an indicator produces and this is the last thing you want to be doing. Those who take each buy and sell signal an indicator offers are likely to lose their trading capital fast. It is not that the indicators are doing anything wrong. They will always do what they are programmed to do. The key for the trader is to use them in conjunction with proper trend analysis. One of the great benefits to using indicators and oscillators the right way is that they allow you to trade based on a mechanical set of rules.
In my New York class last week, we focused on a strategy that uses a single moving average and stochastics. This strategy produced some very profitable trading and again, allowed students in the class to take all the thinking and opinions out of the trading process which is so very important.
QQQQ: Uptrend
Above is a chart of the QQQQ. On the chart we have a 50 period moving average and a slow stochastic oscillator. To begin with, we must assess the trend of prices in this market. For this task, we use a 50 period moving average. Notice that the slope of the moving average is up suggesting we are in an uptrend. Once we know this, we only want to buy pullbacks in price. The mechanical signal to buy comes when the stochastic produces a buy signal in over sold territory (moving average cross, circled above). While this turned into a nice low risk trade, notice the price action just prior to this buying opportunity in the QQQQ. During the uptrend, the stochastic was very overbought, producing sell signals during much of the uptrend which would have led to many losses. This is the trap new traders can fall into when using these tools without logical rules.
Buy Rule: When the moving average is sloping upwards, take the stochastic moving average cross in oversold territory as a buy signal. When the moving average is sloping upwards, IGNORE EVERY sell signal the stochastic moving average cross in overbought territory produces.
The Logic: When prices are moving higher, we want to find a buying opportunity when things are on sale. Furthermore, we want to buy from someone who is selling in the context of an uptrend (a novice trader).
QQQQ: Downtrend
On this chart, we also have a 50 period moving average and a slow stochastic oscillator. Here, the 50 period moving average tells us the trend is down. Once we know this, we only want to sell rallies in price when price is overbought. The mechanical signal to sell comes when the stochastic produces a sell signal in overbought territory (moving average crosses, circled above). While these turned into nice low risk trades, notice the stochastic remains oversold during the downtrend, producing buy signals that will certainly drain your trading account in a hurry. Again, this is the trap new traders can fall into when using these tools without logical rules.
Sell Short Rule: When the moving average is sloping downwards, take the stochastic moving average cross in overbought territory as a sell signal. When the moving average is sloping downwards, IGNORE EVERY buy signal the stochastic moving average cross in oversold territory produces.
The Logic: When prices are moving lower, we want to find a shorting opportunity when prices are high. Furthermore, we want to sell short to the buyer who is buying in the context of a downtrend (a novice trader).
Lastly, is this the perfect strategy? Certainly not, there is no perfect strategy. If there was, that person would have all the world's money. However, wrapping some simple rules and logic around your trading is the key to stacking the odds in your favor. Even Las Vegas does not win all the time. They do well over time because they realize they don't always have to win. They just need to stick to their rules that allow them to keep the edge. This is one of many strategies we cover in our courses. If you have any questions, email me anytime.
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.