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Mulicollinearity (Novice Chart Error)


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Mulicollinearity (Novice Chart Error)

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  #1 (permalink)
 mcteague 
New York NY USA
 
Experience: Beginner
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In another post I mentioned that I had reduced my charts to two indicators; CCI and TSI. At the time I believed one was a trend indicator and the other a momentum indicator. This is totally wrong.

I found this article on Stockcharts on Multicollinearity,

Multicollinearity - ChartSchool - StockCharts.com

(this by the way, is the only other site I recommend. So I hope Mike does not mind the link. I am not sure what the rules are)

In any event multicollinearty is a statistical term for using different indicators to reveal the same information. In my particular case if you use the same time frame a CCI line fits almost exactly on top of a TSI line. I am getting exactly the same information. Not different information. It is important to know what each of your indicators is really designed to show and to make sure you are getting all the that you want from them.

As I am surely not the only person to make this error, I thought I would pass along the link and the concept.
I have made major changes in my charts because of it.

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 Fat Tails 
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This is in fact one of the most common errors that can be observed when studying charts of beginning traders.

Many indicators are based on a projection of price, and what is displayed on the chart is always the same old price wolf, which comes in the clothing of fancy indicators.



To avoid the trap, it is better to use information from different sources such as

- significant past price levels not shown on the chart
- volume
- market breadth (NYSE-TICK, TRIN)
- correlations

No indicator is needed to display momentum or a divergence, rising or falling prices, the loss of momentum creating a divergence can be directly observed from the price bars.

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 Zondor 
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Seeing the same thing in a lot of different ways does not add any value.

In addition to the data mentioned in the preceding post, price information based on time frames other than those of the chart master instrument can be very valuable (Visual MA's, etc).

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