From the November 01, 2011 issue of Futures Magazine • Subscribe!

Clearing up price level trading

The modern trading desktop offers easy access to a wide variety of technical indicators. It is not uncommon for practitioners of technical analysis to have ready access to hundreds of indicators, along with the ability to apply them quickly and in unending combinations on price charts.

"Selected success" (below) shows an intraday price chart of the CME Group’s S&P 500 E-mini contract (ES) with three well-known indicators: Moving average convergence-divergence (MACD), money flow and the relative strength index (RSI). The TradeStation EasyLanguage program that created the signals can be found at futuresmag.com/PriceCode. It shows how straightforward it is to construct systems that in the past would have required extensive programming and technical knowledge.

Each indicator is different, but all can be used to measure overbought/oversold levels. When these levels are reached in combination, a long or short signal is generated. Some implementers will wait for a cross-over to occur — when overbought/oversold levels initiate a reversion to the mean. The approach shown here generates a signal when all three indicators simultaneously reach individual overbought/oversold levels.

Such a price chart of successful trade signals can lure the trader into a perception that the right combination of technical indicators has been found — one that will provide a generally successful trading strategy. But the simple visual inspection of price charts can give a false sense of success.

"Reality bites" (below), taken three days after the first chart, shows the same indicator set producing an unsuccessful trade signal. Both of these indicator charts illustrate a common problem with the use of technical indicators and highlight how indicators that work splendidly in one market context — for example, during a day of rotational price action — will fail miserably when the market enters a trend. The obvious next step for the trader is to attempt to distinguish between rotational and trending markets, often looking to additional indicators that can make the initial attempt more robust.

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