One of the main points I’ve highlighted on intraday Trend Days is that you should remove all indicators (especially oscillators) from your chart and only use Moving Averages to guide your trading. This will serve as the explanation for doing so.
Let’s use January 29, 2009 as an example using the DIA 5-min chart:
You can click for a larger chart.
Before getting too deep in this chart, please read my explanation on how the ideal trades set-up in my previous post on this trend day’s interpretation. I could have shortened that explanation by saying the following (tongue in cheek):
“There were three easy trade set-ups today – sell short any time price pulled back and began to find resistance at the 20 or 50 Exponential Moving Average”
You could have exited each trade as price tested a prior low or made a new low, or more aggressively, you could have held each trade until the close, as that’s what your expectation is on a trend day – price will open at one extreme and close at the other. Pullbacks to the EMAs give low-risk entries as you would place your stop on the other side of the average. Simple, easy, relatively effortless.
But what if you don’t use moving averages or what if you base your trading on some sort of indicator (or combo of indicators)? Chances are you might do well on normal days as you capture price swings, but generally most people who use indicators suffer their largest losses on trend days. Why?
I’ve selected four popular indicators with default settings (RSI, MACD, Slow Stochastic, CCI). I’ve noted the classic (the way all the mainstream books teach you) methods of buy and sell signals. I know, you can interpret indicators differently and that is good, but for this example, let’s use the way new traders are taught to interpret them.
The RSI is perhaps the worst indicator in this example. It only gives one buy signal (price going under 30 then hooking back up) and absolutely NO sell signals (above 70 is a sell signal). This is the flaw of RSI – in powerful moves, it can never give a counter-signal, and has you buying into a strong down-trend day.
The MACD gives three complete trades (or six if you go long/short/long/short). Keep in mind that most newer traders will only take the buy signals which certainly complicates things on a trend day down, having them buy in on retracements only. If you use your own chart or look closely at this one, you’ll see that the MACD never has you buying or selling at a top or bottom swing, but it needs a little push to create a signal, so what might look good in the indicator does not translate into much profits when traded in real time. From noon until 2:00pm, you were whipsawed back and forth with losses.
Where RSI failed to give a decent number of signals, the popular Slow Stochastic gave too many, chopping you around but some trades led to decent gains. I was generous and interpreted the Stochastic to signal a trade on a crossover of %K and %D. In reality, you’re taught to take signals on a crossover ABOVE 80 or BELOW 20, meaning you would have been signaled to buy Five times and sell Two. In that case, Stochastic performs at par or worse than the RSI for the day. Again, it has you BUYING the market five times on a down day and selling it twice.
Finally, I’m showing the CCI (Commodity Channel Index) which I rarely use but is a popular indicator. It appears to have a motion very similar to that of the Stochastic. It generates four buy signals and two sell signals – equally unacceptable on a strong trend day down.
In sum, most oscillators will give oversold signals almost all day long, signaling repeated entries into a market that is falling to new lows throughout the day. If you’re going to use oscillators, you need to filter your trades or use unconventional methods to generate trades that go beyond the classic interpretation.
Or, you could completely remove them from your chart when you suspect we have a trend day developing (which can usually be done around noon) and rely ONLY on moving averages or some other non-oscillating indicator.
All in all it’s your choice – but I prefer easy over complex and what works over what’s supposed to work.
Afraid to Trade.com