Indicators fall into two categories: 1) Price Smoothing, and 2) Market Forecasting.
Using indicators such as MACD or moving average cross-overs you can smooth out the noise in the market.
However, there is no one price smoothing indicator and set of parameters that always work well.
An important principle to understand in indicators is the signal-to-noise ratio. The signal is the behavior
of that market that represents good follow-through after a trading signal is generated.
Noise is random events
that have no meaningful trading value. Noise does not vary from day to day that much. It is the rise and fall
of the signal that usually affects the Signal-to-noise ratio. Choppy markets have a low signal-to-noise ratio
and trending markets have a high signal-to-noise ratio.
There is no direct way to measure signal-to-noise ratio in the market. With practice you can improve your ability
to judge the action and make an informed judgment on the signal-to-noise ratio.
The daily range of the market fluctuates with different times of year and with economic conditions. The summer
usually has a smaller range than other times of year. When the S&P500 forecasted earnings are changing rapidly
due to boom or bust economic circumstances then the daily range will widen and stay wide until the earnings outlook stabilizes.
Another important factor is the tempo of the market. When the pace of trading is high, then the tempo is high.
The number of trades per minute is a good indicator of market tempo.
So markets have different Signal-to-noise ratios, different tempos, and different ranges. These differences also
occur intra-day. A mid-day market on the S&P 500 is not at all like the first half hour.
The key to making money with a price smoothing indicator is matching the smoothing rate to the market conditions.
You want just enough smoothing to give you a clear signal. This will inevitably cause a delayed response when the
market changes direction but you are much less likely to get "whipsawed".
In order to reduce whipsaw trades (where the market moves against you shortly after you enter the trade) you should
have the same smoothing indicator(s) on multiple charts. Each chart uses different time frames and/or different
smoothing settings. Use the chart(s) that appears to be most synchronized with the market. This selection is more
an art than a science and requires some practice.
Market forecasting indicators attempt to use market information to spot a strengthening or weakening of the current
trend, or to confirm a change in the trend.
There are several indicators that fall into this category: Volume, Price Pattern (e.g. ADX, Stochastics/RSI, ARMS index,
TICK, A/D line, and Candlestick patterns like the Doji). When used as confirmation, they can backup the smoothing
indicators to improve your success rate.
Market forecasting indicators are also subject to the same issues as the price smoothing indicators and are more effective
when used on different time frame charts and with different settings. At www.customizedtrading.com they have some unique indicators
that can be very helpful. Their normalized volume indicators allow you to compare the current bar's volume to what is normal
for that time of day. That extra insight is quite valuable.
Derivative markets sometimes provide the opportunity to analyze the underlying for a better understanding of the trend. The
emini S&P500 futures contract is a derivative of the underlying index, which is a derivative of 500 stocks. By looking at small
group of key stocks you can gain insight on the whole group (See the article on using Tells). There is also the volume of the
contract and the volume of the 500 underlying stocks to consider.
In my view, the most important market forecasting indicators is volume. Learning to read volume will give you an edge.
TICK, ARMS index, and A/D line are not as good as volume. I also think the A/D information runs a minute or two behind the market.
