Here are the 3 best technical indicators
I received an email
comment today from a respected market observer:
“Obviously, with the plummet we had yesterday, everybody’s wondering what the
trend is…you might want to consider mentioning something like this.” I emailed
back that trend followers don’t predict. My associate responded with: “I would
venture to guess that you look at long-term weekly and month charts and that
some longer term up-trends are still in place…(and that is worth mentioning.)”
Of course the “plummet” yesterday was replaced with a gain today! This
interchange got me thinking that no matter how many times trend following is
explained, the basic concepts can still be hard for many people, even experts,
to “get”. For example, trend followers are not chart readers. They don’t use
charts to project into the future. Consider this good trend following definition
from Van Tharp: “Let’s break down the term Trend Following into its components.
The first part is “trend”. Every trader needs a trend to make money. If you
think about it, no matter what the technique, if there is not a trend after you
buy, then you will not be able to sell at higher prices…”Following” is the
next part of the term. We use this word because trend followers always wait for
the trend to shift first, then “follow” it.” Christopher Cruden, a technical
trader, took the definition a step further when he spoke at the Alternative
Investment Management Association: “…as many investors and a number of members
of the press know to their chagrin, a technically driven investment approach
inevitably leaves the manager without a quotable view. His (or her)
belief/expectation/notion that the euro, for example, will rise or fall against
the Swiss franc may or may not be interesting cocktail party conversation but
has no impact upon the way the computer will react…I would prefer to finish with
a certain currency forecast, based upon my own fundamental reading of the market
and one which underpins my personal investment philosophy. This is that the
dollar will inevitably trade at 0.5 euros and at 2.0 euros. The only problem is
I can’t tell you when this will happen or which event will be first. On that
basis alone, it seems best to stay with our systematic approach.”
Sounds easy enough, but some people either can’t
or won’t accept trend following for what it is. And there is a smaller minority
who continue to question trend following’s validity, vehement in their belief
that prediction is an absolute necessity: “So, in other words, you trade
according to a system the signals of which are not associated with whether price
will move both in the right direction and to a certain minimum extent after the
trader has committed to a prospective entry? Good luck. You’re going to need
it.”
That is correct. Trend followers never have
knowledge of some minimum extent move after an entry. How could anyone know the
a minimum? In my book, Trend Following, I address the misconception that you can
predict anything head on. A recent discussion post also frames the issue
correctly: “Technical Analysis is attacked for what people wish it could do.
Trend following like any form of technical analysis is a risk management tool,
not a price prediction tool. Once again, this is why (anyone’s) demand for a
predictive model using trends is downright silly. There is no such model and
that is not inconsistent with the fact that trend following is a valid form of
technical analysis.”
In discussing the downsides of the prediction
mindset, another trader offers: “Although I’m sure there are folks making money
by predicting price (perhaps you are one of them), I’ve never actually met one.
All the good traders I know use probability instead. Personally I didn’t start
turning regular profits until I got rid of the prediction framework. Also, there
was a long time where I thought I surely wasn’t predicting price, but in fact I
was (attempting to do so). These things are part of the long and painful growing
process (to overcome). The only way to avoid it…(is to think in terms of
a)…probability framework from the beginning.”
However the logic of these posters is lost on
this reader who recently wrote me: “Suppose your trend following system suggests
you buy a stock today. Your system uses daily data — it is a short to
intermediate trend trading system that often holds positions for days or weeks
if they remain profitable. But also suppose, you have 100 percent certainty that
the opening price tomorrow will be more favorable for entry than the current
price (say the stock is going ex-dividend). It just so happens, that this
decline would stop you out of the stock, causing a loss. Are you really going to
tell me you would still buy the stock, even though you KNOW that the price will
be more favorable tomorrow?”
To say there is 100% certainty about tomorrow is
an extremely slippery slope. No Trend Follower believes tomorrow is more certain
than today. You can only operate in the here and now. Forecasting the future is
great for cocktail conversation, but bad for trading. Other people have written
me where their confusion about core differences between fundamental analysis and
trend following is stark: “There is nothing incompatible with fundamental
analysis and Trend Following, nor Elliott Wave and Trend Following. So it is on
you to demonstrate any contradictions.”
Life is about choices. You can’t be a trend
follower and base your decisions on fundamental analysis or Elliott Wave
(whatever Elliott Wave is exactly is a debate in of itself). Trend Followers
(Dunn, Seykota, Henry, Harding, Tropin, etc.) trade very similar and objective
methods. Where are the Elliott traders? Where are their performance numbers?
When you say fundamental what do you mean exactly? Think about it this way:
Losing traders forecast where the market will be tomorrow. Winning traders react
to what the market is doing right now. Ask a great trader where he thinks a
market will go and he will probably shrug and say the market will go wherever it
wants to go. Reaction is about the business of making money, prediction is all
ego (and delusion). Trend Following success is ultimately a measure of market
psychology. Trends, like epidemics, build in geometric progressions. Some people
jump on the bandwagon; some get in early either by chance or luck. Finally there
is a critical mass that makes it possible for even more people to simply hear
about the trend and get on board. If you design a strategy to take advantage of
this basic human behavior, you can apply it to a broad range of markets from
cotton to currencies to stocks, and win. So for all of those expecting the
magical grail or some secret sauce to explain market behavior or offer
predictions for tomorrow, consider what the 3 best technical indicators in order
are:
1. Price
2. Price
3. Price
Michael W. Covel is the founder and President
of Trend Followingâ”