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 âdynamicâ line like a 144 WMA (in the case of a daily chart) youâll 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 âshowsâ 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 âcause 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 âslopeâ green/red will define Wave Highs and Lows
What is the good of it?:
Option 1: You donât 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 âfalseâ lows/highs especially in fast timeframes or less liquid instruments. (For an example
http://www.elitetrader.com/vb/showthread.php?s=&threadid=113456&perpage=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 wonât 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, itâs 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 âslopeâ 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 thatâs 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 donât 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?; Iâll continue later with a SPY intraday 0.1 constant range chart.
jjrvat
PS: TheRumpledOne, thanks for posting these additional self-explanatory real live examples of the power of pure price analysis.
