Garbage In,
Garbage Out
Chart patterns and technical indicators
are not created equally. A highly skilled technician can trade
successfully using only a price bar chart. But the most powerful set of
market indicators has little value when viewed in the absence of price.
Just try this exercise: buy a stock at "oversold" and sell it at
"overbought" without looking at price. Not a good way to make
money.
Chart patterns reveal quirks of crowd
greed and fear behavior. They are universal fractals that repeat
themselves over and over again in all time frames. Best of all, they point
to the exact locations for low risk trade opportunities.
But the mind plays tricks on what the
eye perceives. The human brain attempts to construct order from visual
chaos. Randomness fed to the mind responds as perceived pattern.
Unfortunately, this false order may tranquilize the eye but lacks truth or
predictive power. And it destroys trading accounts.
Newer traders should never rely solely
on patterns for trade execution. Reading price patterns requires little
effort while serious study is needed to interpret technical indicators. So
many newbies take the easier path and fail miserably when their profit
depends on correctly interpreting these complex tools.
Technical indicators filter out the bias
of the organizing brain. Physics teaches that energy sources leave
telltale signatures in the form of exhaust or radiation. Similarly,
patterns with true predictive power should emit evidence that indicators
can detect and measure. When signals converge through these discontinuous
forms of analysis, odds increase sharply that the trade setup is valid.
Shorten your learning curve by
understanding two common quirks of indicators.
Over the years, endless variations of
the same few studies have been published. Stick with the classics until
they stop working for you. And regardless of origin, all indicators suffer
from the same limitation. They only work in certain market conditions.
Learn what those conditions are before you trade.
Overbought? Common wisdom says to
sell when Stochastics punches above 80. But that advice would have cost
you money during PSFT’s 100% gain in 1998. Always look to the pattern
first before interpreting your technical indicators. In this case, the
only important message was "the trend is your friend".
