Using Technical Indicators vs Trading Based Purely On Price And Volume Charts
The focus of tonight’s posting will be on indicators. The debate among traders over advantages and disadvantages of using indicators will never cease. The purpose of this post is to offer you additional insight into my trading philosophy. The term trading philosophy is indeed the most appropriate one as there is no correct answer or absolute truth regarding the use of indicators. It all comes down to your personality and the way you see the markets.
In my FAQ section I state I do not use any indicators. The only exception would be the occasional use of moving averages. My whole focus is on price and volume. This is a decision I made early on in my trading career. I used to plot Bollinger bands, OBV (On Balance Volume), plenty of moving averages and Fibonacci retracements on my charts. Then I tried to be even smarter and every now and then added MACD, Stochastics, RSI and ADX to the mix. You get the picture. I ended up with what I call ‘Spaghetti Charts’. You take a clean chart and literally throw spaghetti onto the chart until it becomes completely unreadable. The result is the well known ‘analysis paralysis’.
One could argue wise use of indicators won’t clutter the charts as to make them indecipherable. I won’t argue with that approach. But as I outlined above I made the decision to go with completely uncluttered, clean and clear charts a long time ago and have never looked back. The reasons why I made this decision are manifold and are deeply rooted in the way I view the markets.
The main reason has and always will be my desire to ‘keep it simple’. Dennis Gartman is a well-known proponent of the ‘keep it simple’ theory. Contrary to popular belief ‘keeping it simple’ is not easy. Quite the opposite is true. One of the reasons is the inability of market participants to:
* Embrace Ambiguity
* Embrace Uncertainty
* Embrace Doubt
The nature of the markets is by definition uncertain. The outcome of a single trade can’t be predicted. Novice traders wrongly assume losses can be avoided. Nothing could be further from the truth. Losses are an integral part of trading. Traders can’t control the fact losses will occur. What you can control though is the size of your losses. Once you firmly grasp this concept you will understand and willingly accept working and trading in an environment characterized by ambiguity, uncertainty and doubt.
The understanding of what markets really are and what they are not will then lead you to abandon the search for the elusive holy grail. The perfect indicator. The perfect chart set-up. The stuff dreams are made of. Real trading is different. You put on a trade. You don’t expect every trade to work. (Some great traders even go so far as to recommend expecting every trade to fail. They do so because they understand what trading is all about.) You always accept losses gracefully. Then you move on and find the next great trading opportunity.
Here is a list of additional advantages that come to mind and will pay off in the long run if you make it a habit to look at charts without using indicators:
* Less procrastination
* Eliminating the need for additional confirmation
* Keeping it simple, clean and organized
* More focus – less noise and distraction
The last two points are the main reason why I decided to write this post. Being focused, organized and seeking a deep understanding of markets and price movements is what I devote my time to. My job is to listen to the charts and to reduce noise. One way for me to reduce noise is not to use indicators, as indicators are derived from price and volume. They are price ‘derivatives’. The underlying psychology is that indicators therefore can’t possibly lead price as they are only a ‘representation of reality’. Hence my all time favourite quote is from Jesse Livermore:
‘Everything you need to know is right there in front of you’.
Something else to ponder on is the fact great traders isolate themselves from others, Linda Bradford Raschke Trading Rule Number 9. It is basically their way to reduce noise. That includes turning off the TV and spending too much time reading news releases. The need for a ‘reason’ or to ‘understand’ why something happened is due to the fact most traders do not understand the concept of ‘Price Risk vs Information Risk’ Justin Mamis wrote about extensively in his book: ‘The nature of risk’. That’s why I include that one in my recommended books section. I will write more about that topic at some later point in time.
Be objective. Is a stock moving up or down? Focus on reality. In the markets price is reality. When all is said and done, focusing on price and volume exclusively will drastically increase your understanding of the markets, how pressure builds and how price movements are structured. Over time that will make you a better trader.
Embrace ambiguity, uncertainty and doubt.