INDICATORS: A “GPS” SYSTEM FOR TRADING
Some possible thoughts for newer traders
Some possible thoughts for newer traders
Traveling one morning to an unknown destination, my automobile GPS system suddenly said “Prepare to make a U-turn.” This was a heads-up that I would shortly need to make a “change-in-direction”. That change was not immediate, since the operative word was “Prepare.” I actually passed a couple of roads to the right and then traveled almost a half mile before the GPS said, “Now make a U-turn.”
Five days a week (except for holidays) options traders start a journey in the stock market towards an “unknown destination”. We don’t know where the market will take us, nor do we know its ending monetary destination? As an important note: neither do the Market TV Business Pundits know where the day’s market will end. As such, it might be helpful to have a good “GPS Market Trading System” to help make decisions along the way.
My wife is sitting here in the office with me and just asked: “Why are those candles on your chart going up and down?” I told her that is an excellent question and that the stock market is a lot like life. Life has its ups and downs, although it usually moves sideways, and like the market chart we never know which way the next candle might move? Sometimes our internal GPS system is our only guide as we move through life!
What about the market, and how are we going to navigate through this day?
First, we need a good charting vehicle that includes a GPS system to help reach our destination. For me that GPS system is called “Indicators”. Indicators can help show when to “Prepare for a Change in Direction.” Some of my Indicators have a tendency to repaint, we may pass a road (indicator arrow) or two before any trend change actually takes place. Because of that reason, my charting is comprised of “multiple indicators” looking for possible change from more than one perspective.
We need Indicators that track money flow, overbought/oversold conditions, natural pivot points, support/resistance, and Fibonacci levels where computers might be programmed to buy or sell. There may be other parameters as well, and I’m always seeking one’s that have a 90% chance for providing indications for a probable trend reversal to take place.
Let’s first take a short look at some market dynamics.
Most of us learned the Bell Curve (a graph depicting normal data distribution) in High School. The Bell Curve shows that distribution takes place within three Standard Deviations. In a normal distribution curve, about 68% of data falls within 1 SD, 95% within 2 SD, and 99.7% within 3 SD. Options in the market are mathematically designed, and priced, to fit within 1 SD. The market uses several parameters to derive that 1 SD for each stock (ETF). Some of these parameters include price, volatility, time, and a few Greeks thrown in for good measure. As with the purchase of many things in life, an option begins to lose value as soon as it is purchased.
First, most indicators are oscillator driven, which is why we want different parameters for each of our indicators. Without different parameters for each indicator, we would only need one indicator. Multiple indicators provide the opportunity to see changes in trend taking place from different perspectives.
My first indicator of interest is the ORB (Opening Range Breakout). During the first 15 – 30 minutes, the market sets its High/Low parameters for the day. As a rule, the chosen security (stock, ETF) will trade between these two ORB levels unless it breaks out above/below the ORB.
Since the market is designed to trade approximately 80% of the time between a 1 SD High and a 1 SD Low, those areas become important pivot points to take into consideration. Other pivot points of interest are the previous day’s High/Low, as well as Support and Resistance Levels (which I like to show as a cloud). Fibonacci levels can also be major pivot points (8, 13, 21, 34, 55, etc.) which are Moving Averages – my preference being EMAs (Exponential Moving Averages) which are slanted more towards current values. My charting includes the 8/20 EMAs with a favorite trade being the crossovers of these two moving averages. My favorite day trading is a 5-minute chart, although other time frames may be used as well.
It is usually good policy to let the market settle in for a short period of time before placing trades. The first couple hours are usually the most active periods of the day. Some traders only trade during the first 1–2 hours.
A favorite indicator on my chart is the PSAR (Parabolic Stop and Reverse) which helps determine the direction an asset is moving. History shows that candles tend to move 6–10 bars on each time frame before changing direction. The PSAR shows where the last change in direction took place, and on my chart there is an upper label showing how many bars ago that transition took place. Of course, in a strong uptrend or downtrend, movement can be a lot more than 10 candles.
This may be more information than a person needs, however this represents a collection comprising my personal GPS system for placing trades. Statistics show that 90% of option traders lose money, and my guess is that most of them have no Charting (GPS) System in place? Many losing traders are probably “gut” traders, which has never proved to be a reliable trading system. Dilbert the cartoon wondered, “where do you place your head to listen to your gut?” My worst trades have always been when I thought I knew better than my indicators.
This site “useThinkScript.com” has a lot of charts and indicators to choose from. I would encourage all new traders to pick a charting setup that fits your eye and especially one that has at least 3–4 indicators showing probable trend changes, and then use it as your trading GPS system. (Of course my preference is my personal charting: “AGAIG-BestTradingChartSetup” posted a few weeks ago although there are many good other choices also available on this site).
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