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TheRumpledOne
6,358 posts
msg #62746
Ignore TheRumpledOne
modified
5/17/2008 4:58:26 PM

The thread is located here:

http://elitetrader.com/vb/showthread.php?s=&postid=1871292&highlight=Direction+Indicators+Macro+direction#post1871292

04-06-08 07:24 AM

Developing a price based trading plan (PBP)

Indicators #5

As long as indicators are used only as visual aids, they are not going to cause distortions (and there is not a trade off). In the case of the example:

Direction Indicators (Macro direction)

144 WMA

If instead of using fix S/R as a reference you introduce a “dynamic” line like a 144 WMA (in the case of a daily chart) you’ll have the same results. Look how the green dot line pointed at the same supports as the fix S line.

How to use it?:
Price above/ below “shows” at a glance where is the market going.
What is the good of it?:
In this particular case nothing special, the fix support line is so clear that the 144 WMA only show the same. But in general it avoids drawing macro S/R lines, its dynamic so it adjust to current circumstances.
What are the potential shortcomings?
None as long as you use it only as a visual aid for macro direction.

Price Analysis Indicators (Wave analysis and current direction):

25 HMA
Here is where the problem starts ‘cause the reasons behind why and how you use this indicator will have considerable influence in the outcome of your trading plan.

How to use it?:
Option 1: As a visual aid. Just to have a quick visual aid for waves and +/- to recognize where the market is in that particular moment (Current direction).
Option 2: To establish wave Highs/Lows = your decision to take a trade will be based on this analysis. Change of “slope” green/red will define Wave Highs and Lows

What is the good of it?:
Option 1: You don’t gain a lot but you can have nice quick visual reference of the current direction.
Option 2: You may reduce whipsaws on sudden price spikes that can point to “false” lows/highs especially in fast timeframes or less liquid instruments. (For an example http://www.elitetrader.com/vb/showt...6&pagenumber=45)

What are the potential shortcomings?
Option 1: None as long as you use it only as a visual aid.
Option 2: If you are not carful you can misinterpret price and take a trade based only on the indicator and not on price analysis + you may not take a valid trade because of the indicator. In the case of the example the second arrow won’t be a valid entry anymore because is a lower high (when on reality price made a higher high (H1=1.4918 < H2=1.4929)

As you can see this is one of the tradeoffs I was talking about. You introduce an indicator to improve efficiency and you end up losing consistency. There are millions of cases that the opposite will happen; the indicator will get you in without exact confirmation of price HH/LL but the key issue here is to recognize that every time you introduce an indicator you will have to deal with this tradeoff. Moreover, it’s very important to recognize the exponential implications of this in your trading plan. This a daily chart where waves are naturally smoother but look at the potential implication of introducing a 25 HMA in a 8 tick chart where you can have 100 waves in 1 hour multiply that by the implications of 2 or 3 indicators you may decide to use, you may end up in a net of conflicting signals that will certainly be reflected in bad trading decisions.

Indicators for triggers, exits and failures (Timing)

25 HMA as a trigger instead of the random line

How to use it?:
Either you can trade a close above/below the HMA as a trigger or you can wait for a conservative change of “slope” green/red for confirmation
What is the good of it?:
It can give you an objective entry point, reduce drawdowns and identify warnings that the trade is going to be bad and/or clear exit signals
What are the potential shortcomings?
Late entries and exits

As you can see in the chart the 1st and 3rd trades would have been triggered +/-130 ticks and +/- 170 ticks above the original trigger based on the random line. (Either if you entry on the close above or if you waited for change of slope).Even worse are the exits both trades would have been losses (+/-100 ticks and +/- 200 ticks) if you have traded only the indicator signals. Again that’s not the key point, there are many cases in which the opposite would have happened, the crucial issue is to recognize why, how and the cui bono of your indicators? If you don’t know this and you pretend to find a holy grail that overrides all the tradeoffs between indicators/efficiency and price analysis/consistency you are doom to fail in the long run.

It sounds nice in theory but how to you do this in a real small day trader chart?; I’ll continue later with a SPY intraday 0.1 constant range chart.

jjrvat

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The thread is located here:

http://elitetrader.com/vb/showthread.php?s=&threadid=113456&perpage=6&pagenumber=64

Ironfist NQ example

This is a good example on the implications of price analysis, indicators and perspective in a simple trading system. I will only focus on the factors that are relevant to this thread…

The original system

“The only indicator I'm using is a 60EMA. Go long when the price goes above it, go short when the price goes below it.” IronFist

A PBP example based on this trigger

Timeframe

1. 500 Volume Bars. The original post was 1 min chart but for obvious reasons, volume charts will reduce a lot of whipsaws when trading a moving average as a trigger.

Direction Indicators (Macro direction):
1. 240 WMA: As a visual aid for macro direction. Price and slope above/ below
2. Daily Pivot Points: To visualize if the market is going to keep moving in one direction or its going to change and also for potential profit/stop targets

Price Analysis Indicators (Wave analysis and current direction):
1. PRICE: For wave analysis. Blue/Brown dots indicates if price made highs or lows in the last 5 bars

Indicators for triggers, exits and failures (Timing)

1. A 55 WMA: Go long when the slope goes up; go short when the slope goes down. I did that to further reduce unnecessary whipsaws. For the sake of the analysis bars are colored according to this condition.

Summary yesterday US MORNING

Blue arrows: 3 perfect entries all winners = Macro direction ok (red 240 WMA slope) and Wave analysis OK (HH/LL)

1st Trade: Max profit range 66 ticks / Drawdown to the max profit range 1 tick / max time in the market +/- 24 mins
2nd Trade: Max profit range 10 ticks / Drawdown to the max profit range 1 tick / time in the market +/- 2 mins 30 secs
3rd Trade: Max profit range 18 ticks / Drawdown to the max profit range 2 ticks / time in the market +/- 27 mins

Orange arrows = 9 valid potential trades but not according to the trigger. All of them had at least 4 ticks max profit range

Red arrows = Reversals but very advanced trades. Observe the first 2 highlighted circles both at pivot points and how the red bars after the reversal green bar failed to break the pivot and make lower lows and compare with the last highlighted circle (also at the pivot) in which this didn’t happen (and therefore the downtrend continued).

I leave you with the chart and I’ll post my comments on it later.

jjrvat

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