Leading and Lagging Indicators, Achieving a Balance (Part 3)

01/23/2008 12:00 am EST

Focus: STRATEGIES

Joe DiNapoli

President, Coast Investment Software Inc.

If you are using high quality leading indicators, the advantages of this type of trading are substantial. You can achieve an extremely high percentage of winning trades. In addition, your orders will be filled with a minimum of slippage, because you are buying a dip when the market is coming at you and you're selling a rally when the market is advancing. If you're trading size, this can be a huge advantage as compared with initiating a trade with buy stops or sell stops. If you're trading a two lot, this approach can be significantly beneficial on your execution as well, but more on that later.

Is there a downside? Obviously! It takes some experience to learn just how to employ the techniques. Let's say the market approach you're using to determine the direction has indicated a strong up move. You're buying a dip within that up move but you placed your entry order too conservatively, on a support point that is not reached. The market takes off without you.

If you do this repeatedly and you're right eight out of ten times about the overall market direction, you're going to be filled only on the two times you're wrong! This can be frustrating to say the least and underlines the need for the accurate use and thorough knowledge of high quality leading indicators to make the methodology work. Another problem arises when you're taking profit objectives. You come to a clear point of resistance, you clear your trade, and the market keeps going. If you're not a disciplined trader, you may end up getting right back in "at the market", just as the market is about to have a serious correction. If you're managing money, you may have some explaining to do. This problem can be mitigated if you trade multiple contracts. You can always hold some. I have tried this approach over the years, and I've found that exiting all positions at predetermined logical profit objectives is always better for my bottom line.

Another method you can use to accommodate runaway bull moves is to reenter the market on pullbacks against support points on lower time frames. Let's say you may have exited a daily position on Tuesday and you reenter it on a half-hour chart on Thursday. What's interesting about this approach is that even if you reenter the market at a higher price, you may be at a safer level. That means that statistically you would be less vulnerable to adverse volatility that could hit your stops and force you to take a loss. This approach allows you to control risk without raising your stops to areas likely to be hit!

Stay tuned for part 4 tomorrow.

By Joe DiNapoli of FibNodes.com

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