Thinking Beyond the Trading Signal

wallst.pngWhen you take a signal, do you consider why you are taking that signal? When you exit, do you know why you do so?

On the surface, you might say “I enter when I perceive prices moving a certain direction, and I want to flow in that direction” and “I exit when I feel the move will no longer continue, or the move did not unfold as I expected.”

That is exactly what you should say. But do your trade entry and exit signals say this at a deep level?

Let’s assume you use an oscillator to enter trades. When the oscillator reaches a certain value (oversold/overbought), then you will enter. But what does that oscillator value really mean?

If the RSI is reading 20, it may mean that the market is “oversold” and due to rebound back up – but you cannot take this (or any) signal in complete isolation.

Ask: “Does this signal tell me information about the most likely price movement?”

In fact, a better question might be: “Will this new information cause traders to alter their perception of the current environment and switch their positions as I expect them to?”

In other words, if you are expecting a price reversal to the upside, think a minute about what is likely to CAUSE that price reversal.

Is it because an indicator hit a certain value? Probably not.
Is it because a market hit a certain level, be it a previous support zone or moving average? Probably not.

Prices move because traders – in aggregate – reach certain conclusions at different times. Where one is buying, another is using the exact same price for selling. What matters is the aggregate decisions of all participants at a specific price level or zone. If a signal works, it is because enough traders perceived it and acted on it to cause the movement, and disturbed the market balance of supply and demand.

When price reaches resistance, some may sell their position, others may enter a short trade, others may hold because they have not identified potential resistance, some will buy because a fundamental or news reason has occurred (which has nothing to do with technicals), some may buy early, anticipating a breakout, others may buy because they cannot take the pain any longer of mounting losses in a short position, and various other esoteric reasons.

Each person – or groups of traders of like-mindset – will put buying or selling pressure on the market at a given price, and the true “battle” between seller and buyer will move prices. Some will enter and the market will move against them and be proven wrong and exit. Some will enter, be proven right, and enter a larger position. A portion of price movement is sometimes due to stop-losses being triggered.

Conclusion:

Price movement occurs as a result of a complex interaction between buyers and sellers for reasons that are often unknown. It does NOT occur because an indicator said price would move a certain way. It does not move because the ADX is low, the Stochastic is oversold, the MACD is crossing, or the market has pulled back to a moving average.

The next time you take your trade, identify possible forces that will work to support your trade idea and forces that will work against it. See if you can anticipate the winner of the “battle” between buyers and sellers at a given price and if you think and analyze deeply enough – and capitalize on the side that is losing – then you should improve the accuracy of your signals.

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