Technically, no indicator is really "false" or "true" at any point in time... it's just a calculation of price movement. Certain types of indicators are designed to capture certain types of price movement. For example, a moving average is specifically designed to be used with trending movement. If you try to use an MA in a range with a period that is too long, you will just end up getting whipsawed as you constantly get long at the top of the range, and short at the bottom. On the other hand, if you use it in a strong trend it will perform beautifully.
Stochastics and other oscillators are mathematical calculations that assume a ranging type of movement. They make the assumption that when price extends itself, it will pull back. Based on that type of market movement in a range, stochastics (or any oscillator) will work beautifully... but in a trend, they will constantly turn in what you would call a "false" manner as the trend continues against you.
Technically, none of these movements are really "false" or "true", it's just a question of using the right tool for the right market condition. Trying to trade stochastic reversals against the trend or MA crossovers in a range is like trying to play tennis with a hockey stick... it's the wrong tool for the job. Therefore, your job as a trader is to give yourself a proper set of tools that appeals to you, and then understand the correct market conditions in which to use these tools. No indicator is going to tell you when market conditions are changing with 100% reliability... it's just too complicated to program or backtest. However, if you stare at the market long enough, learn to recognize the different types of movement that it makes, and then learn to recognize the very small signs that occur as it transitions from one phase to another, you can learn to apply your tools properly using your own intuitive feelings and experience.
Let's take a concrete example:
Suppose a market is in a consolidation range. It's going up and down. You notice this, and decide to trade it using a stochastic or some other oscillator. So you start taking a few trades and make some money. However, after some time you start to notice that your last couple of trades haven't worked, and looking at the chart you now notice that it has changed into a choppy downtrend. It's no longer really in a range - one side is starting to win.
So now you switch over to an MA on a chart that you have designed for this condition, establish a short position as it comes back to the upper trendline of the choppy movement or approaches this MA, and just hold this position. The market continues to move down as the bears start to drive the bulls further and further. At this point, the bulls start to notice more obviously that the market is no longer in a range, and some of them try to push it back up in a desperation move. Maybe it spikes a bit further up than usual in response to this attempt and you are stopped out with a small profit. At this point you now re-evaluate: will the bulls succeed in creating a new trading range here, or are the bears going to hand their heads to them?
Let's say that the bears respond to this little bull "line in the sand" by immediately driving it back down with some larger sell orders. Uh oh. The bulls are now in trouble. The choppy trend resumes, and you decide that it's correct to still employ your "choppy market downtrend" strategy so you get short again the same way you did the last time. You know what is likely to happen next: the bears will likely push the bulls to a breaking point where they start to capitulate. The trend may very likely accelerate into a faster downtrend as this happens. It may not happen, but you are looking for the signs if it does.
So let's say that it does start to happen now. Trading speeds up. Price accelerates to the downside. Now, because you are prepared for this, you immediately switch to your "rapid downtrend" strategy. You use a faster MA to better capture this movement, because you know that the most likely thing is going to be a spike low, followed by a reversal of some magnitude. You know what to look for, because you are expecting this type of movement. Perhaps you try to play a few counter-trend moves, perhaps you don't - but you always have a condition in mind that will dictate the "end" of this new and faster downtrend (a lot of this is price-action based). Incidentally, playing counter-trend moves under these conditions is often not a good idea because you have to be very good and very fast... and it's generally not worth it.
So let's say that you are holding a short position, and now the market REALLY spikes down in a huge push and moves very far away from your moving averages, and then pauses. You now know that it is very likely that the trend will retrace back upwards for a certain relatively far distance, as the selling has finally been exhausted, at least for a while. You compare how far the price has travelled at this point away from your MAs, and realize that it is very overextended to the downside. You know that this is the case, perhaps because you have some indicators on your charts designed to show you this condition - maybe something like an MA envelope or bollinger bands. Maybe you notice on a longer term chart that it is also hitting the opposite side of a downward-sloping trend on this higher timeframe, which makes it a good candidate to bounce back to the upper end of the long-term channel. Furthermore, a simple calculation tells you that this downtrend has now gone about 80 ticks, which is typically how far crude oil will run in a trending movement before any significant retracement. (Let's say that's what you're trading.)
So you realize that this is likely to be a good candidate for "the" bottom for this particular downward movement, and decide to enter long with a tight stop immediately. Likely it will be "the" bottom, but even if it isn't, it will probably travel enough ticks back upwards to give you a small profit if you lock it in with a rapid stop. Worst-case scenario, you are fooled and lose a few ticks as it spikes back down through your tight stop. If this does happen, you do not get short again, because you realize that it is very overextended and it's not worth the risk/reward. Instead, you wait a bit and see how it acts. You evaluate how the bulls react to this little "final, final" spike, and if they drive it right back up. If they do, it's a good bet that it's still the bottom and that was just the dying gasp of the downtrend.
Let's just say for the sake of argument that it does start to move back up from your initial long entry and doesn't take you out with a "final, final" spike (usually it doesn't, especially if you can read price action and know the proper time to get in). You now have a very specific set of indicators that you look at to determine when this larger counter-trend upward bounce is over. You have created these indicators by looking at many months of past data and seeing what happened before for this instrument and how it moved under these conditions.
So let's say that now you hold this newly rising market for a good 25-40 ticks. You know that there are two things that can happen: it can be one of those times when it just retraces the entire recent 80 tick down move and REALLY screws the people who got short at the bottom, or more likely it will be one of those times when it just retraces a good way before retesting the bottom again. Let's say it's the latter. Price has gone a certain distance pretty far away from the spike bottom now, and starts to turn back down, so you exit your profitable long position and get short. You do this, because you have been looking for signs of this downward reversal, knowing that it's the most likely scenario.
You are very cautious at this point because you don't know how far it's really going to go back down. It could go a fairly short distance and then reverse violently back upwards in a "gotcha" move, which will tell you that this is one of those times that the uptrend is stronger than you thought. Or it could accelerate down and break the spike low, but that's unlikely after such a large retracement back up, which you now notice is much larger than any of the previous ones in the downtrend that occurred. Most likely, it will go down a good ways, and then make an attempt back up to the intermediate high it just made. Let's say you have a set of MAs tuned for this purpose, so you know what to look for and when to get out if it starts back up. Let's say it does go down a decent amount towards the low (all of this happens pretty fast), and then does start to reverse back up. You are stopped out of your profitable short position for a reasonable small gain.
At this point, experience tells you that all bets are off. The easy money has been made, and most likely we are back in the beginning of a range. The trading may still be relatively fast as bears and bulls are throwing some orders at the market right now, but you notice that the momentum is dying and it's not making a clean break past the intermediate high and low that were just formed. Let's say that past experience has told you that this particular condition (dying trend) is too difficult to trade because the price chops up and down too fast, so you stand aside. As the market continues to slow down, you now notice that a new range has been formed, so you go back to your original stochastic strategy. You start looking for signs again in this range for which way it is likely to break out when it does, and decide to only take range-bound trades in that direction. You also start constantly looking out for signs that the range is over and that a new trend is starting, drifting either up or down. Basically, go back to step 1.
This is just one example of how you could trade a particular market scenario, and it doesn't always follow this exact pattern. The key is knowing what to expect from the market, and that comes from staring at it live and going back over historical data for many, many days and months to see what it did in the past. By knowing what it COULD do in any given situation, you know what to look for at certain key points, and you have different indicators tuned to each condition. You know when to use your stochastics and when to use your MAs, because you are very familiar with how the market moves in various phases, and how it transitions from one condition to another. When you determine that the correct condition exists, you trade a certain system until it starts to fail or you determine that new conditions have arisen. The key is to be constantly on the lookout for changes in market temperament as I have described. There is no easy way to gain this knowledge other than just putting in thousands of hours staring at it and making notes. The good news is that your account balance will in and of itself tell you when conditions are changing, because you will find that certain types of trades stop working. So if you start losing money trading stochastics crossovers at one point, just stop, step back, and re-evaluate if the market conditions are actually appropriate for it.
Last edited by FBJS; January 7th, 2010 at 01:49 PM.
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OP your premise is utterly false and here is a lagging indicator for tradestation to prove it. it lags by precisely the periodicity of the chart you apply it too.
plot [-1] (Close);
BTW to convert it into a leading indicator that predicts tomorrows close change -1 to +1
Many indicators lag. Not only do they lag but you can compute precisely how much they lag by.
For example a simple moving average is a digital low pass filter. (it filters high frequency components whilst passing low frequency ones). You can reduce the cut off frequency (at the expense of lag introduced into the data that is passed) by increasing the averaging period. It is not rocket science but it is mathematically sound.
I heard once that if you are driving and the car in front indicates it is turning left, most probably it will turn left, but maybe not immediatly, more than likely it will, however sometimes the indicator could have been accidently switched on and the car may not turn left.
I read into this that indicators are exactly what they say they are, it is up to you to from that moment on. Indicators are very helpfull lagging or not, without them we would all be trading in the dark
Well you didn't read my point or didn't understand it, but if you see lag in indicators you don't look and understand them correctly.
You see I don't care if its a 100SMA or 200SMA or what ever. I make an assumption that if price is above the 200 SMA and then goes down it will retract to the SMA and bounce up again. Thats the assumption. So I look into future and I test this assumption. If it has a statistical edge I'm glad and I trade it. I don't think well I can reduce the lag by referring to 100 SMA or 5 SMA...
Its like you say that the sun rises in the east and travels through the sky every 4 minutes the distance of it diameter. Thats what I see and its good for my purposes, to know where the sun will be in 2 hours. Now you come in and say, I was taught in 5 grade that the sun is not traveling through the sky, but the earth moves. You may be right but for the purpose of knowing where the sun will be in 2 hours my point of view is better.