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February 12, 2007

In this week's free newsletter, we'll take a look at  Trading With Indicators.

Some traders swear by their indicators.  I've encountered more than a few who think that when it comes to colorful indicators, the more you can use the better off you'll be.

One trader in a day trading office I used to trade in would fill up his charts with so many indicators that it looked like a 3-year old had taken a bunch of colored markers to his screen.  In fact, price was almost completely obscured.  Imagine that!

I'm not here to dispute the validity of indicators or suggest that they have no purpose.

I AM  here to tell you that indicators each have their place in trading, but they must be applied properly to get something out of them.

My preference is to keep my charts as clean as possible.  Price and volume are the biggest factors in my trading, and every indicator available in technical analysis is derived from either price, volume, or both.  That's why I focus on them.  Occasionally though, I will apply an indicator or two, but it is always to merely confirm what price is already telling me.

Example:

I highlighted BWLD as a short sale in Sunday night's Bandit Broadcast newsletter due to the small descending triangle pattern on the daily chart, as well as an unfilled gap from last October.  The stock was hovering at short-term support, and a break below the $49.40 level was my trigger to get short.  I applied the Balance of Power indicator (BOP), a proprietary indicator which shows systematic accumulation or distribution in a stock that is exclusive to Worden Brothers (the makers of my charting program TeleChart).  My feeling from the price action was that distribution was already underway, and the BOP indicator confirmed this.  Here's the original chart I highlighted Sunday night:

TCNet chart courtesy of Worden Brothers, Inc.

Today, BWLD triggered a short sale for us for a very nice day trade, ultimately giving us a $1.74 move in just a matter of hours.  It was a fun ride to catch, and I was glad to have had the confirmation from the BOP indicator because it added to my confidence in the trade.  Here is a look at what the stock did today:

TCNet chart courtesy of Worden Brothers, Inc.

If you're looking at ways to use various technical analysis indicators in your trading, keep these 3 things in mind before you apply them:
 

1. Use Indicators to Confirm what You Already See.  Let your chart analysis of the stock provide your hunch and then let the indicators confirm or deny that hunch.  False signals are far more common when trades are taken from indicators alone, so be sure to analyze the stock in the proper light and only at that point add your indicator.  This will give you the highest odds of success.

2. Don't Crowd Out Price!  Price is the most important indicator there is, and it simply cannot be argued with.  Respect it at all times, and keep it at the top of the priority list.  Observe price characteristics like momentum, gaps, and support and resistance because a stock's movement will be directly impacted by them, and the indicator will only follow.

3. No Indicator is Perfect.  A case can be made for any indicator, but don't ever fall in love with one so much that you refuse to accept that there is no magic bullet.  There is a place for every indicator in technical analysis, but there is not one single indicator which works at all times.

Remember, indicators are tools which are available to us to assist us in determining price direction.  They are EASY to overuse, and that only serves to confuse!  Limit your use of indicators and you're likely to find that you get fewer false signals and more profits along the way.

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Jeff White
President, The Stock Bandit, Inc.
www.TheStockBandit.com

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