The technique outlined below is suitable for discretionary traders. It is based on a fairly complex data analysis which has been translated into a set of proprietary tools. Before describing these tools, we feel it is important to have these first guidelines in mind, gathered along nearly 15 years of experience:
1) Most indicators, either custom made or built in trading platforms, do calculate one or several mathematical outputs at each bar. One may also (correctly) say that prices are noisy, chaotic in nature, which obviously make "market reading" rather difficult. However, in my opinion, the problem is elsewhere... Indeed, most of the time, there is simply nothing to read in the market, not necessarily noise, but just irrelevant useless information. To be quite pragmatic about it, let's say that buying and selling are essentially discrete decision points, the rest is 'vacuity' which should be handled by money management, i.e. keeping an eye on your position.Trading should therefore always inherently remain dependent on an event driven technique. In other words, if you wish to crunch large amount of numbers in any crude or sophisticated way, irrespective of the rare salient events where effective decision making is only sensible, well... you might just be wasting your time... and LOTS of so-called trading gurus are quite willing to take you for a ride along the meanders of the never ending quest of the Holy Grail... (note: LOTS is still a huge understatement...)
2) Any sound decision can only make sense in perspective or context, unless you stick to quick scalping or to the simplest reversal strategy, assuming you get your pivot calculations right too.The best way to represent context is to work in a multi-time frame environment (2, 3 or even 4 time frames). It seems obvious that a move in your time frame of choice, determined by indicators lining up nicely either long or short, can only show strength if supported by a similar set-up in a higher time frame. Choice of adequate time frames may however not always be easy, and one could only hope for a trading platform in the future which would have adaptive bar intervals.For synch purposes, time frames will often be in multiples like 1, 2, 4, 8 minutes. In addition, some will prefer finding confirmation from 2 or more higher time frames. Others may find more suitable to balance their time frame analysis with one higher and one lower time frame. It is likely that using a conservative rule base over 4 time frames can reduce trading ambiguity to next to zero. The trader's risk adverseness is key here as he/she will have to devise a rule set based on indicators confirming each other on different time frames making trading as comfortable as possible.
3) There are always times of congestion, relative market inactivity, which will inevitably affect indicator calculations. One way to reduce such impact on indicator reading is to opt for tick charts or volume charts, or alternative market representations like Renko charts. Congestion on a time frame should indicate going higher or lower. Most traders will try and go to a lower time frame to detect waves or cycles he/she can trade. It is however on the contrary often recommended to go higher, or even better go both higher for context, and lower for trading points.
4)Markets are highly dynamic. Prices are chaotic, non stationary etc... Still, this is no reason to try and throw everything but the kitchen sink into your favorite trading platform. Do not forget to still be able to fully understand the method you are trying to put together... You are the trader... don't ever forget this subtle point. Successful traders always know the finest details in trading calculations. Do not underestimate 2 things however: stats will be in most cases wrong as they do imply stationarity that is just not there. Secondly, many many 'market cycles' gurus will find cycles in a market that cannot produce any stable cycles. One way to put it is that if you look hard enough, and with a bit of faith, you'll always find what you are looking for. It is a common mental process distortion.
5) Markets are chaotic, and contain fractal features. Once you have found a sound technique, it should work the same on another set of time frames, as well as on other financial instruments. This is the 'acid test'. Many models just fit one instrument on a single time frame, and are bound to fail sooner or later. There may of course be some adjustments needed (not more than a few degrees of freedom if possible) to adapt from one instrument to the next, but not more than that.
6) I personally do not use astrology, lunar cycles, solar eruptions etc... I am not going to debate Darwinism, the Big Bang or other esoteric sources either. Some say trading is more art than science too... Scientists like me would rather say there is still some unexplained fuzziness in markets, a LOT of unknown stuff in Nature, and that's much better that way... we, humans are so big headed already... so please stay humble...
These forewords may sound like vague generalities, and there are admittedly many ways to spoil a cat (I love cats to i had to twist that cruel expression a bit), but they can be a crucial time saver to you in the end, and most important may prevent you from wandering around lots of trading costly dead-ends...
1) A prerequisite to trading in my opinion is some knowledge of Fibonacci numbers, and in that respect, I can for instance recommend reading Jo DiNapoli's books. Most traders calculate Fib retracement and expansion numbers. There is more to it, and I may write about it at some point, although there is already ample literature on the Internet. Be careful though not to be too 'trigger-happy', Fib is still no panacea. It also fails!
2) Another very interesting calculation tool is the Murray Math Lines algorithms. It is still a proprietary algorithm, I believe, but it has however been mimicked and rewritten for most platforms nowadays. We of course have our own. A *FREE* VBA version of the algorithm is freely available on a MS Excel spreadsheet.
3) Adaptive indicators which calculate OK in a multi-time frame environment, such as stochastic indicators. Stochastics have that annoying tendancy to respond to a fairly narrow bandwidth. Try and make them as adaptive as you can, and when they lose efficiency, just jump time frames.
4) Get yourself a good pivot algorithm. It may at first look like just another display method for swing analysis, but there is more under the bonnet... Pivot sequences (in 2 or more time frames) can be used to derive waves, and can be used with advanced artificial intelligence algorithms to detect the next pivot hence patterns with sometimes very high probability. We use a numbering scheme (pivot classification somewhat remotely inspired by Clyde Lee).
ForeTrade - November 2007