ForexSpirit

There used to be a time when I was as fascinated with technical indicators as I’m sure most newbies to the trading world are even today.

I would chop and change the indicators on my charts. Wildly trying to find a combination that would give me an edge, or even some confidence or, hope beyond hope, a clue as to what was going on. Regularly it just felt like I was running around in circles. Or trying to climb a mountain by digging a hole.

I would come across a new technical indictor, either uncovering it in a new charting package or via a trading website. I would throw the indictor on my charts and spend hours trying to figure out if there was any merit in keeping it around. I would come up with new buy and sell scenarios based on how the indicator worked and what other indictors I would be using at that time, and then go back in time on my charting package. Bar by bar, I would scroll my charts along, manually simulating the passage of time. I would make notes of any entries or exits that would occur, totalling my profit or loss along the way. I wanted to see the new indicator in action, so that I could become more familiar with it, and how it looked on the chart, rather than feeding it into an automated trading system.

It eventually became clear that adding technical indictors to my charts was an attempt to increase my certainty that any decision I made would be right, when all it was doing was increasing the complexity of what I was doing. My focus soon began to shift, and I was determined to make things simpler. I realised that my charts needed to be as simple as my trading methodology, as described in my Keys to Trading Success post.

Nowadays I like to have my charts as uncluttered as possible, and pretty much just have naked price on my screen. Not that I’ve thrown the baby out with the bath water. I will still use the occasional technical indictor, but instead of having it on-screen all the time, I will just add it when I want to see what the indicator is saying, and then remove it when I’m done.

With all that said you may be wondering what I do use on my charts.

What are all those red and blue triangles that seem to all over the charts you can see on this website?

A blue up arrow represents where I have initiated a long entry. A red downward arrow is where I have closed out an open position. Since my one direction is currently long euro, all my entries are blue arrows, and the close of all these positions are red arrows. If I begin to enter hedge positions against my one direction, I will choose different colours for these arrows, so that I can easily differentiate between them, for example, my current thinking is to use purple down arrows for initiating a short trade, with a green up arrow showing the close of a short position.

These arrows are therefore purely to show me when and where I have exited trades, and in no way are used in the decision making of new entries. More than anything they are just a handy reminder of how many open positions I currently have in the market.

The number beside each arrow shows the gearing that has been used for that entry or exit. I use a different gearing ratio depending on which quadrant of my grid the position is being opened in. My current trading plan stipulates that my gearing is the following:

Q1: 3:1 gearing
Q2: 2:1 gearing
Q3: 1.5:1 gearing
Q4: 1:1 gearing

To give a quick example, say that I had a $10,000 trading account, and I was about to enter a new trade in my bottom (Q1) quadrant. I want to use a gearing of 3:1, which means that I want to open a position that is worth $30,000 (10,000 x 3). I would thus place an entry order for three mini-lots (given that a mini-lot is worth $10,000).

If I had a trading account size of $50,000, then a Q1 entry would be 15 mini-lots (50,000 x 3 = 150,000).

A Q4 entry, would be just 5 mini-lots (50,000 x 1 = 50,000).

The only other lines of note in the majority of my charting pictures are horizontal dashed lines at various price levels. These are just handy reminders on the chart of where the extremes and centre line of my median grid are. Since my current grid is a 400 pip range on the EUR-USD set between 1.25 and 1.29, you will notice dashed horizontal lines at these price levels, as well as at 1.27, the middle of the grid.

The following chart shows how price has been contained within this grid range for a rather long time now.

The small number of technical indicators that I will still allow on my charts, even if it is for just a short peak at what they show before they’re removed again, are the detrended oscillator and fibonacci levels.

I use the detrended oscillator to highlight overbought and oversold conditions of a currency pair. The only time I will use this indicator is on making a decision of when to exit from a position that has made a large move of at least 100+ pips in a single day. I will use the detrended oscillator to determine if the large move has run its course yet or not. I do this by comparing the current value of the detrended oscillator to other recent peaks or troughs that are visible. If the current position of the oscillator is similar to or has exceeded other recent extremes, then I will use that as a good sign that the current move has exhausted most of its potential, and will then look to close out any open positions.

I generally only look at the detrended oscillator on the 4 hour chart.

This month’s edition (November 2006) of Currency Trader magazine contains a rather good statistical look at the size of moves in the EUR-USD pair over the last year. This can provide useful information on how often you can expect a move of 50 or 100 pips to occur on any given day. Being aware of such probabilities can aid in decisions of when to take profits.

The only other indicator of note that I will use are fibonacci lines on daily and weekly charts. Fibonacci lines can be good at identifying additional support and resistence levels. The only fibonacci levels I place on the charts are the 38.2% and 61.8% values. If you are placing more than one set of fibonacci levels on the same chart, they must all use the same anchor point. Each 38.2% and 61.8% line on its own only represents very minor support or resistance, and as such I will not pay much attention to them. It is only when the 38.2% level of one set of fibonacci lines lines up with the 61.8% level of another fibonacci set that I sit up and take notice. The lines don’t have to exactly match up, but the closer the better. Such an overlap of fibonacci levels is termed a confluence area, and can provide very strong support or resistence.

The following chart shows such an example of confluence at the 1.25 level, which has held very well for the last several months.

And this is how fibonacci lines look on a weekly chart:

I learned how to use the detrended oscillator and fibonacci confluence levels in Joe DiNapoli’s Trading With D-Levels.

Far too often indicators are used to provide confidence and improve certitude that the next trade will be right. The trader can’t handle the prospect of another losing trade and so they continually add new indictors, hoping that they can filter out all those losers that make them feel terrible about themselves.

With my approach to trading, whereby I enter at certain price levels generally for no other particular reason than it has managed to move into a price range that I think is worth buying at, given the potential movement to come, is completely different than looking to enter exactly when one or more technical indicators reach a magical value or move a certain way. I came across an interesting quote today that is attributed to the great economists Keynes, whom supposedly said, “Better to be roughly right than precisely wrong”.

Expecting to have technical indicators provide you with certainty in your trading endevours is nothing more than a falsehood. The indicators are mathematical formulas. The realm of mathematics is seen as whole and pure, providing definitive answers to complex problems. Unfortunately, trading is not so cut and dry. You’re trading with and against other human beings. They don’t care what your technical indicators say. It helps instead if you embrace that randomness and chaos.

If you want to base your entries off what technical indicators tell you then you have to be attentive to those indicators all the time. If you place your trades manually, then you need to check the indicators each time you have a new bar on your chart. If you trade off 15 mintue charts, then you need to check your indicators every 15 minutes on the dot. If you trade 1 hour charts, then you need to check every hour.

Since I don’t use technical indictors as the basis any of my entry decisions, I’m not tied to having to look at my charts at set intervals. If there’s a chance that there might be a good setup on a given day I’ll probably check my charts more frequently then if I determine that it’s going to be a slow day and I’d be better off spending my time doing something else.

I want trading to provide freedom, and being tied to having to check charts all the time is not going to give me what I’m looking for.

I’m not saying that all technical indicators and trading derived from it is bunk. People obviously make a lot of money out there using just such indicators, putting together automated systems that they are able to profit from. One common statement I have seen time and again about such systems is that they don’t last forever. Markets change, and thus the underlying principles that underpin an automated trading system can become invalid. It can be expensive when such a system is nearing the end of its usefulness, unless you are able to run multiple such systems simultaneous, all the while looking to develop new systems to replace the current ones as soon as they become obsolete. Such a setup requires a lot of time and effort, more than I’m willing to make for the potential rewards.

If you are a systematic trader, and you know that in your heart of hearts, then that is the road you need to travel. I know that I am a discretionary trader, and that my talents and time are better spent elsewhere.