Market Speculator FAQ: What Indicators Do You Use?

Swing Trading Pattern Recognition

Beginning stock traders love indicators. They feel that the "secret sauce" is hidden in some combination of indicators and timing. For this reason, "What indicators do you use" is not only a common FAQ, it's the second most frequent (after "how much money can I make trading").

Subscribe to The Market Speculator by Email

Please retweet if you liked this article! Tweet

Many are disappointed when I tell them I only look at moving averages and stochastics, while sometimes peaking at RSI to spot divergences. Last week I even had an e-mailer tell me I was hiding my strategy from them!

Here is the reason I use so few indicators, and even those are usually unnecessary.  Almost all indicators are measuring two things in some for or another: price action and volume.That's it!

Guess what? Your eyes can spot price action and volume. An advanced trader doesn't need the indicator. After studying thousands of charts on a daily basis for over a decade, the advanced trader doesn't need indicators. The eyes tell it all through pattern recognition.

So study charts. Religiously. On a daily basis. Thousand of them, over and over again. Pretty soon you'll spot patterns in seconds without needing confirmation from an indicator.

The Best Indicator is . . .

Way back in November I asked readers to submit questions for a Q & A session. The response was much more than I anticipated, and even after setting time each week to answer questions, I still have not finished answering half of them. So, rather than answer them all in one post, I am going to start posting my answers one at a time.

Jim asks:
What do you believe is the best overall technical indicator to use in trading a stock?

Market Speculator:
Wow, one indicator huh? That's a tough one, although I do like the Zen-like approach of using as few indicators as possible. As the saying goes, keep it simple stupid (kiss). I am a firm believer in simplicity, in all walks of life.

When I first started trading, I was a slave to indicators and probably have dabbled in just about every one imaginable. I have tested some extremely complex systems with mixed results. My breakthough came when I stopped focusing on indicators and zoned in on price and volume patterns, along with support and resistance levels.

These days I only look at stochastic and obv (on balance volume). To tell you the truth, I don't even need them, but they can be helpful in quickly identifying oversold and overbought stocks, along with spotting divergences.

I do pay attention to the following key moving averages: 10, 20, 50 and 200. This is in line with my strategy of watching key support levels, both in price action and moving averages.

I know I still haven't given you an answer yet, Jim. Gun to my head, I would pick OBV, since it is one of the better expressions of volume.

Better to Play the Second Bounce

It's easier to play the second bounce, as opposed to trying to time the first. If you take a look at the chart above (SPY vs T2108), it is obvious that there is no sure fire method in timing the bottom of a correction.

The T2108 indicator (via telechart) measures stocks above the 40 day moving average. While it can be used in many ways, the most popular is to use it as an overbought/oversold indicator. When it reaches 70/80 or higher, the market is in overbought territory. When 20/30 or lower, and the market is oversold.

Notice that going back to 2006, major bounces and trend resumptions have occurred anywhere from 40 to almost 0. Therefore, it's tough to say one should jump in because the indicator is at 20 and is oversold.

However, I have more confidence in picking entry after the first major bounce. Almost every bounce has pulled back in both price and indicator reading. Assuming history repeats itself, that is when I will take on larger long side positions.

Indicators are not the be-all and end-all!

Lately I've received many e-mails and comments asking me why I made a trade when so-and-so indicator was divergent or not giving a buy or sell signal. This comment left by Rey is a good example:

"It looks like I don't see eye to eye with you sometimes regarding going long on stocks that are about to break out with divergance such as MACD, OBV or any others... all the books I have read teaches don't get in on break out if there is majar divergence...what am I missing here?

and also what is your favorit book(I was just layed off work so I got some more time to fill) and what softtware do you use to find and analyze stocks if I may ask..."

As I've stated before, I use indicators as a secondary tool. Sometimes I don't even look at them. I am a slave to price and volume patterns, along with support and resistance.

Earlier in my trading career (if you can call it that), I placed more emphasis on indicators than I do now. If there is an indicator out there that I have not studied or used, I would be surprised. As I've evolved as a trader, I've taken a more intuitive and simplistic approach. As a consequence of viewing, literally, over a million charts, I trust what my eyes tell me. I'm not going to back out of a trade I like because one or two indicators give me a negative signal. Especially when I could probably find an indicator or two that give the exact opposite signal!

That's not to say indicators have no value. I do like to use OBV, Stochastics and RSI (the only three I use regularly). However, I am not a slave to them, and will defer to my own judgment if it tells me to do the opposite of what these computations tell me to do.

That's exactly why I traded GRMN, on the $105 breakout, although there was a divergence. The stock hit $108 today. Divergence be damned!

The four five books that I recommend most are on the top right margin of the blog. It's tough to pick one, but if I had to, it would be one of Thomas Bulkowksi's chart pattern books. The Farley book is good, if you have some background and don't mind reading through dense material that at times doesn't make sense.

I use Telechart for my evening chart reviews and scans.