I am currently drafting several pieces about my own personal views and methods of trading. This is a section on Indicators. Feel free to kick it around, after all, it's only money. :-D
The Indicators
There is really only one thing, and one thing only, that I need from the market in order to make money. Price movement. In fact, were I allowed to have only one piece of information from which I had to base my trading decisions it would have to be, and need only be, price movement. 90%-95% of my trading focus is centered on price action. The charts on my screen need, and mostly have, only the price of the trades and the volume. These are two items of information I can gleam just from watching a streaming ticker. The charts make it easier to keep up with multiple issues. They also make it quicker to build in my mind a history.
What if I gave you the challenge of investing in just one stock? I will guarantee you two things only, this stock will not go to zero and it will have profitable price movements. I am removing the problem of picking stocks. To make money all you will have to do is buy on the upswings and sell on the down. Now you will want some information about the movements of this stock. I am going to give you any chart in as many time frames as you want. The chart can have any indicator or measuring device you want on it, but, it will not have a plot of the price information in any form. The narrowest moving average you may use is the 20MA (simple or exponential). I am keeping the lower MA's away because they nearly allow you to see the price action. Although, I could probably go all the way down to the 10MA and it would not make much difference in the outcome. Further I will give you any FA information about the company that you request. I will give you a live feed into several news services so you can track the rumors about the stock. You cannot have any information about the actual stock prices. Now would you be willing to invest your hard earned life savings into trying to make money on this stock? If you answered Yes, you are already broke.<g> If you answered No. Why not?
Perhaps for the same reason that you would not go down to the Daytona race track get in a stock car and cruise around the track at 200 mph. At least, not with a blindfold on and me setting in a passenger seat yelling turn (I am not telling you which way until after you complete the turn), turn harder, more, now gas it, now straighten out, btw that turn was a right hand turn and it was a 95 degree turn. Good, Good, now we are in the straight away just ease over a bit, not that way, look out, look out. We might make it past the first turn but we wouldn't make it much further before we ended up in the wall.
Indicators do not indicate a change in trend. It took me a long time to understand and apply this in my trading. What they really do is indicate, measure, give a reading or tell you that momentum is increasing or decreasing. Let me say that again, They tell you that MOMENTUM is increasing or decreasing. When you step on the brakes of your car, the feeling that you are being forced forward against the seat belt is an indicator. It indicates that the momentum of the car is being decreased. It does not mean the car is turning or reversing (I use the term "turn" loosely to indicate a change of direction it includes reversing). It may lead to the car turning. It may just lead to a stop and then you may resume your forward direction. As you then step on the gas pedal you feel a force pushing you back into the seat. This force is an indicator. Again it tells you momentum is changing. It does not tell you the car is turning or reversing direction.
Momentum = Mass x Velocity. Mass in the stock market will be the "volume" of the buying or selling demand. Velocity is the speed at which the price is changing. Direction is not a part of the definition of momentum. In the physical world direction will play a part in calculations if you want to know the future direction of an object colliding with another object. However in the stock market you are only going in one of two directions and the stocks are not going to veer off at an angle. Therefore we can ignore direction when examining momentum. Change in an indicator tells you there is a change taking place in the momentum of price movement. It can be a change in the mass or volume of the buying/selling or it may be a change in the Velocity of the price movement. A change in either is a change in momentum and will produce a change in the indicators. It does not require a change in trend and it tells us nothing about reversals. Just as watching a car come to a stop tells you nothing about what it is going to next. It is accepted that in order to reverse one must first stop. Thus, stopping allows for but does not require reversing.
I check indicators all the time but I do not let them guide my decision. Nor do I use them for the basis of my decisions. I use them merely as a curiosity to see if they add any strength to my position. I will look to them many times when I am analyzing a position, but this often happens after I am already in the position and I am just killing time waiting on the price to move. Again, I use them primarily as an adjunct for forming an opinion on the rate at which a trend may be losing or gaining momentum. I do this because I know that a car must first stop before reversing.
Ever jump a moving train? When I was younger my brothers and I used to jump trains moving on the tracks near our house. They had a hill to climb just as they left town and were still going slow as they passed our house. By the time they got to the top of the hill (where they entered a tunnel) they were moving at a pretty good clip. The length of the train (thus mass) determined how fast their momentum would increase (assuming equal powers of acceleration, which we determined by counting the number of engines running when they passed). Now I didn't know these terms, or concepts, when I was a kid. But, I could look at the length of the train, count the running engines, and pretty well judge how far I could ride. A long train could be ridden all the way to the tunnel. A short train had to be jumped off of about ¾ of the way up the hill. You could not get on the train, except a really long train, unless you were near the house. Otherwise, they were going too fast to catch. There is point of velocity at which it is not possible to get on a train but you can still get off with little or no damage. It is easier to get off a fast moving train than to get on one. Point of the story? If you are going to get on the stock at all, the nearer it is to your entry point (near the house) the easier it is to board. If you wait until it is half way up the hill you may get hurt. If you try to jump on, too far after it has left the entry point, you could get killed.
This brings me to some final observations on getting in or out. It hurts a whole lot less to get out of, or try to get into, a car that is stopped. Stepping in front of a moving train or falling stock can really hurt. Jumping off of a moving (climbing) stock can leave you with the pain of missed profits. IF You Have Some Other Reason for getting in or out of a stock when the momentum indicators tell that all motion has ceased, or is down to a slow crawl, that is a good time to get in or out. Do not assume that no momentum means that the next direction is going to be opposite the direction just prior to the stop. If you think a stock is going to change direction and are wrong about the change in direction your "stops" should get you out before momentum really gets to rolling again. That is why "your first loss is your best loss". If you give your stock time to pick up momentum in the wrong direction and then you have to bail out, It Is Going To Hurt. :-)
I was reading through some of my old diary entries today. In the future, I am going to type some of them up. You will smile (or die laughing) as you read my thoughts and emotions when I would discover a new indicator I had never heard about or used before (like MCAD). First I would think I had found the Holy Grail of trading. Then after some time and many lost dollars, I would realize there was something about the process I did not understand and if I kept trading based on the indicators I would soon be broke. It was a long time later that I realized looking at an indicator was like looking at the tail end of a car speeding away from you. When the indicator light comes on (unlike a car) it is not a turn signal telling you the car is about to change direction. It is instead, a breaklight telling you the car is slowing down. There is a minor difference. But it cost me major dollars to learn this. <g>
It's time to oscillate out of here, step on it dude. :-D
KK
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