The Art of Trading Ambiguous Charts

08/04/2011 6:00 am EST

Focus: STRATEGIES

Price Headley

Founder and Chief Analyst, BigTrends.com

Not all charts tell a story, and in fact, most are neither bullish nor bearish, which proves the importance of developing a trading system that gives reliable signals and staying committed to it.

In response to many recent questions, we’d like to address a topic that seems to be a hot button with a great number of traders: You’d like to know about the trade selection process.

More than ever, a totally systematized trading plan is necessary. With the ease of access to market data and historic volatility, traders need to immunize themselves against this potentially harmful environment. Based on some questions, however, it really sounds more like you’re looking for a way to make sure you’re actually finding the top opportunities. The solution really is simple, but too often overlooked.

You must have some sort of methodology or system to find the best opportunities. It doesn’t need to be a complicated system, it just needs to show positive results over time. In fact, the best trading systems are usually quite simple.

Besides profitability, the only other thing your system needs is a means to send you a signal, to let you know to place a trade. While this may sound like common sense, too many traders seem to forget these basics.

The Value of a Proven Trading System

First, you must have an edge:

Ever notice that the market seems to zig just when it’s completely obvious that it should zag? The market’s direction typically defies conventional logic about half of the time.

There’s nothing wrong with using assumptions and logic to make market forecasts, however, you must absolutely concede to the fact that an assumption or logical conclusion may be wrong. We’re human, and as such, we’re going to be swayed by fear and greed. That fear and greed, though, can warp our logic so much that we’ll rationalize anything—even the wrong thing. When that happens, our logic becomes flawed and we become less profitable as traders.

So how does one get around the problems that fear and greed can create? A trading system! Most readers may be assuming that by “system,” we’re saying that you need a highly complicated piece of software that can test certain trade signals, and dozens of charts on your computer screen. These things are nice if you’re a highly active investor, but you don’t really need them.

All you really need is a method that you know works for you. These may be moving average crossovers, momentum signals, or sector-based strength signals. It doesn’t matter which one you use—you just have to become proficient at one of them and trade it consistently.

In fact, one of the most famous trading systems is Bill O’Neil’s "CANSLIM" method. You don’t even need a computer to use that one, and it’s a very passive method.

The point is, logic can be flawed, but a trading methodology can overcome flawed logic.

NEXT: How You Receive Signals from Your System

|pagebreak|

How You Receive Signals from Your Trading System

Secondly, you must be able to receive a trade signal from your system:

If you only remember one thing today, remember this: Most charts are ambiguous. It’s especially critical that the pure technical traders understand this. These market technicians are completely reliant on chart data. This can be a problem because at any given time, about 90% of charts are neither bullish nor bearish.

How many times have been looking for trades, and started to hunt just by looking at individual charts? You start with the symbols you know, then you go to the news to see if anything looks hot or cold to the media.

After you look at 20 or 30 stocks, boredom and frustration set in, and you just start picking ones that look like they’ll do. That’s a mistake. You softened on your trade criteria and may have bought or sold a stock for a poor reason.

You want to limit your trades to those 10% of stocks that are actually doing something. But how does one do this?

You have to have some method of receiving trade signals from your proven system. It’s extremely inefficient to look for stocks that simply fit your criteria. Rather, you want these stocks to present themselves to you. This will not only save you time and frustration, but will provide you with opportunities you may have never seen on your own.

There are many ways of getting the data, but the point is this: Give yourself an efficient way to actually get the data you need.

Bottom Line

Systematic signals and signal scans go hand-in-hand. By taking fear and greed out of your selection process, you won’t suffer from the problems of flawed logic. And by freeing up your time and focus previously spent hunting for trades, you can instead focus on trade management.

By Price Headley of BigTrends.com

Related Articles on STRATEGIES