Let’s use a single moving average and stochastics in our attempt to use indicators in our system to find the consistent losing trader to trade with.
Above is a chart of the QQQQ. On the chart is a 50 period moving average and a slow stochastic oscillator. To begin with, we must assess the trend of prices in this market. For this task, I use a 50 period moving average. Notice that the slope of the moving average is up suggesting we are in an uptrend. Once we know this, we only want to buy pullbacks in price. The mechanical signal to buy comes when the stochastic produces a buy signal in over sold territory (moving average cross, circled above). While this turned into a nice low risk buying opportunity, notice the price action just prior to this buying opportunity in the QQQQ. During the uptrend, the stochastic was very overbought, producing sell signals during much of the uptrend which would have led to many losses had you sold short at those times. This is a trap new traders can fall into when using these tools without reality based logical rules.
Buy Rule: When the moving average is sloping upwards, take the stochastic moving average cross in oversold territory as a buy signal. When the moving average is sloping upwards, IGNORE EVERY sell signal the stochastic moving average cross in overbought territory produces.
The Reality Based Logic: When prices are moving higher, we want to find a buying opportunity when things are on sale. Most importantly, our buy signal told us objectively that someone was selling after a decline in price and selling in the context of an uptrend. This can only be the action of a novice seller. A consistently profitable trader would never sell after a decline in price and in the context of an uptrend.
On this chart, we also have a 50 period moving average and a slow stochastic oscillator. Here, the slope of the 50 period moving average tells us the trend is down. Once we know this, we only want to sell to a novice trader who is buying after a move higher in price in the context of a down trend. The mechanical signal to sell comes when the stochastic produces a sell signal in over bought territory (moving average crosses, circled above).
Sell Short Rule: When the moving average is sloping downwards, take the stochastic moving average cross in overbought territory as a sell signal. When the moving average is sloping downwards, IGNORE EVERY buy signal the stochastic moving average cross in oversold territory produces.
The Reality Based Logic: When prices are trending down, we want to find a shorting opportunity when prices are high. Furthermore, we want to sell short to the buyer who is buying after a rally in price and in the context of a downtrend (a novice buyer).
Is this or any trading system perfect? Certainly not, there is no perfect trading system and there doesn’t need to be. If there was, that person would have all the worlds’ money. However, wrapping some simple rules and logic around your trading is the key to stacking the odds in your favor. Even Las Vegas does not win all the time. They do well over time because they realize they don’t have to always win. They just need to stick to their rules that allow them to keep the edge which means betting against people who don’t have the edge.
This is an intra-day chart of the NASDAQ Futures with the same 50 period moving average. In this example, I simply switched the Stochastic for the Commodity Channel index, better known as CCI, we will get almost the same signals.
Technical Reason for Shorting:
1) The down sloping 50 – period moving average suggests this market is in a downtrend.
2) A CCI Overbought reading (circled are on the chart).
Logical Reason for Shorting: Sell short to a buyer who buys AFTER a rally in price and in the context of a downtrend. The only type of mindset that would take this action is someone who makes decisions to buy and sell anything based on EMOTION, not simple and proper logic. This is the pedigree of the trader we want on the other side of our trades.
Trading strategies that work don’t change with time, markets, or changing market conditions. Quite frankly, to think market conditions ever change at all is a strong illusion that can only be removed when one focuses on the foundation of price movement, pure supply and demand. The systems I see working are very simple. The example below is an intra-day chart of the Dollar/Yen. Let’s apply our same basic principles.
Technical Reason for Buying:
1) The up sloping 50 – period moving average suggests this market is in an uptrend.
2) A CCI Oversold reading (circled are on the chart).
Logical Reason for Buying: Buy from a novice seller who sells AFTER a decline in price and in the context of an uptrend.
Uptrend/Oscillator Overbought: Ignore
Downtrend/Oscillator Oversold: Ignore
Uptrend/Oscillator Oversold: Buy Signal
Downtrend/Oscillator Overbought: Sell short Signal
Collection Source: http://www.trade2win.com