Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
10 Rules for Effective Chart Indicator Use
07/28/2014 6:00 am EST
Barry Moore of LiberatedStockTrader.com discusses the ten simple rules for using charting indicators that he’s crafted from years of trading experience.
"There is no liberation without labor…and there is no freedom which is free."—Siri Singh
There are a lot of stock chart indicators out there; we cannot cover them all in detail here, however, the principles of using indicators are as follows:
Understand how the stock chart indicators you are using are calculated and what they are designed to achieve.
When an oscillating indicator moves in the opposite direction to price, this is a vital sign. Learn to recognize divergences and use them correctly.
3—Back Test the Indicators
Did your selected indicators work on this stock in the past? Scroll backwards to one year before. Then scroll forward day by day or week by week to see the indicator change and then ask yourself:
- What is this indicator telling me?
- Would I buy/sell this stock based on the information shown?
- If the indicators worked on this stock in the past, it may have a better chance of working in the future.
4—Use a Family of Indicators
Never use one indicator alone, use multiple indicators, they should mostly confirm each other. Use them as a suite of self checks before making a decision.
5—Use Indicators on Multiple Time Frames
Indicators can tell you different things when viewed through different time frames either intraday, 1-day, 5-day, monthly, yearly. Using different time frames, you can review how far back a trend goes, and see if your hypothesis stands the test of time. Beware that reviewing trends further back than two years may render the data irrelevant. Sometimes markets have a very short memory and stocks can completely change character.
6—Use Custom Timescales
You need to tune the timescales or parameters on the indicators so that they reflect the timescale that you want to invest.
- If you are buying a stock for the long-term (two to ten years), use longer-term time frames and base your decisions primarily on fundamentals, then on chart patterns.
- If you are buying mid-term (six months to two years), use earnings momentum in the last six quarters, plus the chart indicators, moving averages 50-, 100-, 200-days).
- If you are buying short-term (one week to six months) use indicators that are tuned for the short-term, moving averages 10- and 20-Days, money flow, MAC-D (10:30:5), stochastics.
- For shorter-time frames than that, adjust accordingly and utilize faster oscillators and moving averages.
7—Price is the Most Important Indicator
Price is the most important indicator of all, it does not matter what the other indicators say, if your stock is moving against you take action, do not blame the indicators.
8—Be Aware of the Market Influence
Be aware of the markets influence over your stock, if it is a disaster day on the markets, it does not matter what the indicators tell you will happen, your stock can get dragged down with the masses.
9—Pre-Define a Set of Rules
Pre define a set of rules for the trade and test the rules. For example:
MA 10 and 20 Cross Over
MAC-D shows a positive divergence over eight weeks
RSI shows a positive divergence
10—Understand the Meaning of Supply and Demand
Supply and demand can be gauged by using the volume indicator in conjunction with price. You need to understand that fluctuations in volume and price have a relationship and have a meaning.
By Barry Moore of LiberatedStockTrader.com
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