Sunday, September 27, 2020

What Settings Do You Use For Your Technical Indicators?

This was a question recently asked of me during a webinar.  It reminded me of an observation of a trading software vendor who provided expert support for his product.  He said that, whenever he spoke with traders needing support and discussed how they were using the software, in 90+% of the cases, they were using the standard, default values for the indicators.  Very few traders explored or adjusted parameters; they stayed with the familiar.

I have found this to be true among users of very specialized software as well.  Many times, there are very powerful tools that can be found on the platforms, but those go unnoticed by a great majority of users.  The enemy of trading success is not emotion; it's mediocrity.

I do look at some technical indicators, particularly oscillators, but not really in a predictive way.  As one wise observer noted, technical indicators are like weather vanes:  they tell you which way the wind is blowing; they don't provide weather forecasts.

The reason I use oscillators and indicators such as those in my recent posts is that I am trying to gauge the presence of cycles within market trends.  If I can identify a trending market with tools that assess buying and selling pressure, then I want to use cycles within the trend to provide entry and exit points with good risk/reward.

So back to the question:  what settings do I use to identify potential cycles in the market?

Quite simply, I look at the settings that were most effective in tracking cycles for the previous day or two and use those settings as long as the current day's relative volume is not unusually high or low.  Since early 2018, the correlation between today's volume and yesterday's volume in SPY is approximately +.86.  The correlation between today's true range and yesterday's range in SPY is about +.77.  In other words, a solid early estimate of today's market participation is yesterday's participation.  I then track relative volume in real time to see if movement and volume are meaningfully diverging from yesterday's values.

If today is tracking yesterday pretty well, I conclude that, over the short time horizon, we have a relatively stable time series and the presence of cycles yesterday should provide information about cycles we expect to see today.  So that means that the technical indicator settings that were most useful in tracking yesterday's cycles aren't a bad starting point for estimating today's ups and downs.  Of course, this logic applies to multiple time frames and is important when considering the interaction of time frames.

For the active trader, there are few considerations more important than *who* is in the market.  That tells us a lot about how markets will move.  The failure to adapt to changes in the market's movement lies behind many trading failures.  The best trading opportunities don't occur in strong, weak, busy, or slow markets.  The best opportunities occur in relatively stable markets: those moving similarly to the recent past.  That provides a unique insight into "edge" and an important criterion for when to not trade.