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Solution # 3 - Trading Indicators that are proven effective in today's markets

Today's traders realize early in their trading careers that the canned indicators that charting vendors supply are for the most part useless. An indicator becomes useless when it looses its "edge". The degree that a indicator looses its "edge" is dependant upon how well it reflects the fundamental nature of price behavior and number of traders exploiting it. In order to become a consistently profitable trader the trader must be able to perceive and or do things that his fellow traders are unable to. Traders are limited to how they can obtain this edge, and the equipment/tools they can manipulate.  

History of Trading Indicators:

In the VERY early years of trading and investing the hardware tools a trader could utilize were limited to how well we could draw and write pricing information on a piece of paper with his pen! What prevented the common man from becoming a great trader was not a lack of hardware, but rather a lack of software (the knowledge possessed by the professional trader).

Today the situation is much the same. The power of today's personal computer is unbelievable when compared to a main frame of several decades ago! Today's computer possess more computational power than a thousand bean counters and mathematicians of the early 1900's. The charting applications sold today all have indicators that when they were initialized conceptualized and implemented were "cutting edge" and very effective in seeing the underlying reality of the marketplace thereby creating profits for the creator. Yet, these same indicators are often ineffective today. 

What happened? Easy, when the indicators were initially created and implemented only a handful of traders thoroughly understood the logic of the indicator or its math. Consequently these indicators often indicated high probability trades. However, as computer literate traders became more commonplace the effectiveness of these indicators began to diminish. Their effectiveness decreased in almost direct proportion to the number of traders looking at and using them. 

More or less all traders when they begin their trading careers follow the same path.

  1. They first decide they can make a million.
  2. They invest some money and sooner or later loose it all.
  3. They then realize that it is not so easy after all, so they go out and buy as many books as possible that reflect their beliefs about trading. All of these books say more or less the same thing in regards to the indicators included with most charting applications. Consequently the rules on how to use such and such indicator are learned by everyone. Unfortunately the novice trader now thinks that he and he alone perceive the underlying truth about this particular indicator(s) and he will now make a fortune. The truth of the matter is that all of the more experienced traders also know these same rules and most importantly they know when these rules should be faded or broken. Consequently the new traders lose all of their money once again. 
  4. After realizing that the knowledge contained in the books is "dated" as the book was published eon's ago, the now not so novice trader decides he will attend seminars as the information conveyed should not be so dated. After attending some seminars the trader will once again begin trading, although by now he has no doubt learned the mandatory requirements of using money management rules. Now, his trading capital is not yet lost a third time, but instead begins to grow. However, the rate that it grows is slower than our trader likes so he once again starts searching for what he has to do differently.
  5. About this time he begins to realize the truth about "trading knowledge".

So what is this truth? Simple, any indicator that is worth a damn was designed by a trader in response to a burning need to solve a challenge. The indicator is often created as a variation of a previously known indicator. This newly designed/created indicator begins a life cycle all its own. The life cycle is thus:

  1. After being created it is tested in real time by its creator under all market conditions. If it passes these test then it moves on to step 2.
  2. The creator begins to use the indicator to trade real money with. All the time the creator is thinking about how to improve his initial indicator. He might share it with his closes trading buddies.
  3. At some point the creator realizes how the indicator can be significantly modified so that its performance can be significantly improved. At this point the creator will then begin sharing the "first" indicator with his trading friends "associates".
  4. At some point the creator realizes that he can once again significantly improve the performance of the "second generation" indicator, and creates his third generation of indicator. It is noteworthy that each new generation is based upon the original.
  5. At some point the creator will no longer be using the original indicator at all, and realizes that he can release the indicator onto the commercial market by either writing a book, or selling the indicator. The creator is not concerned that the indicator will fail because at the time he releases the indicator it is still working.
  6. Once the indicator is publicly available in whatever shape, its life expectance begins to fall. The reason it begins to fall is because in order for it to be effective and profitable the indicator must exploit an inefficacy in the market. This is what creates the edge required by a trader. As increasing numbers of traders begin exploiting this inefficacy its effectiveness decreases.
  7. Some indicators will remain effective over many years, while others will die an early death. The determining factor is the level of inefficacy the indicator exploits. Is the inefficacy a superfluous inefficacy or does the indicator exploit a fundamental inefficacy of the market?

The Reality of Commonly Available Indicators

There are countless indicators available today. The vast majority of them are available for free either as included indicators with charting applications, or in various trading forums. The majority of all indicators will occasionally work (this is why they are still included in charting apps., and why novice traders swear by them) i.e., they predict future price action occasionally. However, the vast majority will generate false signals the majority of the time. In order for a trader to profitably use a common indicator they must utilize it in a unique way thereby creating their unique edge. Unfortunately there are a zillion traders whom are using the same indicators and there are only so many variations on any one indicator. Consequently the probability that a novice trader will have a "unique perspective" is very remote.

Of the commonly known indicators that are still effective so some degree, the one thing they all have in common are that they reveal or work with a fundamental truth about price behavior. What are some of these indicators? Moving averages, momentum indicators, trend lines, Fibonacci ratios and retracements to name a few. Each of these work with a certain fundamental aspect of price behavior, so they will always be "somewhat effective".

Is this to say that one could make winning trades using these indicators by themselves? Yes, provided the trader had a unique perspective. Is this very likely? For the novice trader, absolutely not. For the professional trader yes, he could make winning trades off of just one of these indicators, Why? Because subconsciously he would be reading between the lines.

Could a novice trader create a winning strategy using just these indicators? Yes, again provided he had the right perspective. When these indicators were first released could of a novice trader made a lot of money? Yes, no doubt.

The bottom line is that the usefulness or profitability of any indicator (or system for that matter) is limited to the how effectively the logic and math of that indicator exploits a fundamental aspect and/or inefficiency in the marketplace, and the number of traders utilizing that indicator. As the price of a publicly available indicator increases the number of traders decrease logarithmic.

The Solution:

DataSharks is very happy to of entered into a relationship with John Hayden whom will be supplying DataSharks some of his personal trading indicators. Mr. Hayden has written two books about trading. The first one titled "The 21 Irrefutable Truths of Trading" was published by McGraw-Hill in the fall of 2000. His second book titled "The Complete RSI Book" is being published by Traders Press in the Spring of 2003. He has decided to begin releasing some of his indicators for a variety reasons.

DataSharks is looking for other documental professional traders whom would like to share their indicators with the public. Please email us.

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