Traders are searching for the holy grail, a single indicator or system that is 100% accurate. However, this is as foolish a search as trying to find the real El Dorado, the fountain of youth or the holy grail itself.
Why? While there are events that are “baked” into the price action of markets. There are also unforeseen events that are not. The market as whole works on the assumption of status quo. What was yesterday will be today and still continue tomorrow.
Unforeseen events, such as a pandemic, sudden death in leadership, sudden departure of a “C” suite executive, sudden and major lawsuit from a regulator, and the list can continue, can and will impact the chart in unforeseen ways.
Recent examples would include the way the lock-downs impact global economies, the sudden investigation of China into Alibaba, rumors of mergers, or mysterious short squeezes on companies stock.
So, minus a holy grail, a strategy should be accurate approximately 80% of the time.
In a strategy you need:
- In-depth understanding of the price action.
- Price action based signals.
- In-depth understanding of consolidation.
- In-depth understanding of the indicators you plan to use.
- An accurate time frame for the indicators.
- Entry signals based on indicators.
- A collection of 6 – 8 indicators, some could be similar (ie, 2 oscillators, 3 moving averages, etc.)
- Sometimes you might bundle an indicator collection into a single indicators (IE the use of 3 moving averages can be re-coded into a single indicator which plots the three together).
- Filtering rules (IE. Don’t take a crossing signal if the two momentum oscillators are opposite the trend).
- Stop/Exit signals based on price action.
- Stop/Exit signals based on indicator action.
Of everything list above, the majority of daily traders don’t have many of these points checked off of their lists. Especially accurate understanding of consolidation, time frames or filter rules.
Why Filter rules are important?
Let’s use a simple moving average as an example.
In using a 10 day moving average, I would adding all the closing prices for the last 10 days together and dividing by 10. IF there is a high close, it is first introduced on day 1 of the calculation when it occurs, after that, even with closes declining (unless they are extreme), it will take approximately 5 days (by day 6) for the high close to move to point where it isn’t heavily impacting the average calculation. This means this signal can continue to climb from day 1 through to day 6. By day 7 you should start to see a down turn in the average. This is the reason a moving average is considered “laggard”, IF you utilize a moving average in this way (I don’t use crossing signals from moving averages).
BUT, if you do use crossing signals from moving averages, a filter can help you detect false signals due to slowing momentum or current/previous consolidation.
Moving averages however are highly effective in daily trading. You need the in-depth understanding of price action coupled with a filter for the moving average(s). Especially once the prices enter consolidation. The world changes during consolidation.
Price action can also generate false positive signals. In an uptrend, this can occur during a trade period where profit taking is happening, while in a downtrend, you can get traders taking short profits and both situations might generate a false price action signal only to turn and reverse in the next day or two.
Enter oscillators. Oscillators can help provide a “filter” for a moving average or price action signals. Oscillators such as BSI (Baseline Strength Indicator), CCI, MACD when properly applied can help filter out bad information. Generally speaking, when a signal is generated, if the oscillator(s) agree, it can be taken as being false.
Why understanding consolidation is important?
Lack of understanding consolidation is in my opinion on of the biggest problems with strategies. 90% of the time prices are in some form of consolidation. It only takes 2 trade periods to generate a consolidation range. I have watched the indexes become stuck in consolidation for over a month without violating the ranges. Stocks can also get caught in the same pattern. Under Armor (UA) prior to a breakout and move was in consolidation for over two months.
In my personal life, I practice SIT (Sprint Interval Training). One of the major components of SIT is a rest period. So, I will sprint with all of my energy for 30 seconds then rest for four minutes. During this “rest” I am in a period of consolidation. I will then once again sprint for 30 seconds. I will repeat this process for four to six times before calling it a day. I have 2 – 3 minutes of actual exercise and 16 – 24 minutes of rest (consolidation). Approximately 88% of my exercise time is spent at rest (consolidation).
Prices behave in a similar manner.
During the moments of price consolidations, signals maybe valid signals, however they are not worth the entire value of a signal generated during the sprint.
To further explain, I practice price projection. So, if the normal value is multiplied by 1 while sprinting, during consolidation, if a signal is generated, it is multiplied by .5 because the price is consolidating or “resting”.
Why is understanding of time frames important?
I have in previous posts given the example of instruments in a car being indicators of current status of the car. In that post, I also pointed out that the calibration of the speedometer is based on a specific size tire on the car and that changing the tire size without re-calibrating the speedometer can cause the speedometer to be faster/slower by up to 30%.
This is the same when using indicators. Every stock has it’s own personal time frame. And this time frame can and often changes daily.
In my research I have found that 21 is an “average” time frame used by many popular stocks with 40 being an average for strong stocks and 7 – 10 being an average for slower stocks. While these numbers are “averages”. They are not accurately calibrated for the stock. Increase the volatility of the stock and the time frame changes to a higher number. Decrease the volatility and the number decreases. This is the reason for the daily change.
If you want “accuracy” and always “accuracy” you should learn to identify this “time frame” on a daily basis.
The other point is that these time frames should be used on “all” indicators. Having a mix of time frames on indicators can create problems. If you are using the out of the box values for a MACD and an RSI, they are not calibrated to the underlying prices and will produce false signals. These signals will frustrate the trader and in the end will lead to constant failure.
Time frames not only daily, but across time periods.
Time frames are not static. The time frame for “daily” prices is different than the time frame for a “weekly” or “monthly” chart. If you are evaluating a stock across multiple time periods, you need to change the time frame in the indicators to reflect the new time period. Otherwise you again be generating false signals.
I will provide a small sample of “daily” time frames for your viewing pleasure.
As of today, January 24th, 2021.
Facebook: 22
Amazon: 25
Apple: 29
Netflix: 18
Google: 23
Microsoft: 19
Nvidia: 26
Tesla: 45
Not including Tesla (currently in a strong uptrend). The average Time Frame for the others is: 23
Subject to change on the next trade day.
What is an example of some my filter rules?
I am not going to write out all of my rules however will include a small sample of the rules I follow:
- Obey only the first signal in consolidation, ignore the rest until consolidation is broken.
- Ignore a signal when two of three oscillators are opposite of the trend.
- Ignore the oscillators when both trend signal generators opposite of the trend.
- Place a stop loss at the low of the signal bar (if the signal bar can’t hold, you want out as soon as possible).
Here is a trade example:
The week of February 10th, 2020, Immunogen (IMGN) generated a price action signal with the intention to move from 6.80 to 7.29, a move that if it had played out could have generated a 7.2% profit. At this particular time, IMGN was averaging ~10% moves of overall price on the weekly chart. The following week of 18 February it slipped but was still significantly above the low of the signal week by the close of that current week. In my trade strategy, two of three oscillators were still positive however both “signal” indicators had switched to opposite the current trend. I exited based on this change in the signal indicators. The week of 24 February began even more slippage. This was the beginning of the pandemic correction and IMGN slipped to a low of 1.95 by mid March.
IF the pandemic panic didn’t begin could IMGN have reached 7.29? I have no doubt in my mind that until exterior forces started to be calculated into the general market that IMGN could have reached that price.
However, with all my rules – I closed my position near the close of the week of 18 February as my indicators “turned over”. I suffered a loss, but it could have been much worse.
I later re-entered IMGN near the low and spent the rest of the year holding until it reached 7.29. Why? Because I still believed in the company. I added to my position a couple of times near $4 and $6. But for that first re-entry, it returned nearly 298%.
My trading strategy with IMGN (in the time I have been trading this stock) had as off 24 February, 2021 generated 61 buy signals. 11 were losing signals (18.03%) and 50 were winning signals (81.97%).
This does not mean that I entered every time a signal was generated, but it helped me to hold through a multitude of months, weeks and days in order to have a desirable outcome. It also helped me on adding to my position as major signals appeared calling for further movement in the prices.
Summary:
In order to build a successful strategy, you need a full understanding of every aspect of the trade. From signals, to entry, to exit/stop positions. You need to have filter rules to help in removing bad trades generated from profit taking. You need to have rules for both “while in consolidation” and while trending. Don’t be afraid of having too many rules. A good strategy covers 80% of the possible situations that can occur while trading.
In the end, after testing the rules out and strategy. Don’t be afraid of bad signals. There are some that just can not be avoided while some exterior event may be weighing in on prices.
Just remember one important fact. Your goal is not a “perfect” trading system that is 100% accurate, your goal is to constantly generate profits with a trading system that will minimize your losses. 80% accuracy is the goal.
Orion Price Prophet 