Back To Basics with Indicators and Oscillators

By Sam Seiden

When walking around an Online Trading Academy classroom during the trading portion of a Professional Trader class, I see the trading workspaces of traders, the charts they are looking at and most important, what lines, circles, indicators, and oscillators are on those charts. This last part is most important because what you add to a raw price chart will likely strongly influence your trading decision. After all, why else would someone add something to a chart? The biggest issue I see in the classroom relates to indicators and oscillators. These are fine tools that can work very well for you if you use them correctly. However, many people attempt to take short cuts and use them incorrectly. In this piece, I want to take this issue back to basics and remind you of what really makes a market move.

Moving Averages



Figure 1

In Figure 1, we have a stock in a nice uptrend. In an uptrend, the ideal trade is to buy breakouts or when price declines to a support level. The question that becomes the issue is this: What is support to you? For many, price support is a moving average. I can't tell you how many times I see people wanting to buy a stock because it is declining into a rising moving average. The moving average itself is price support for them. In the example above, price does stop falling and turns higher right at the moving average but that's not really why it turns there. It stops falling and turns higher because there is actual price support at that level. In this case, the moving average happens to line up with that price support but this is not always the case. In fact, much of the time the moving average does not line up with real price support (or resistance). What happens to the new trader who fails to learn to identify real price support and resistance is that examples like this reinforce something that is simply incorrect. If I did not draw in the support zone on this chart and wrote an article about the power of ONLY using moving averages and showed this example, new traders would think moving averages by themselves serve as real price support. It is easy for this illusion to become your reality. You will only know it's an illusion when your trading account draws down so much that you begin asking yourself how and why markets really move and turn. It all comes down to support (demand) and resistance (supply).

This is not to say that indicators and oscillators don't work or that we should not use them. The key point here is that we want to use them in conjunction with price support and resistance. Indicators and oscillators are fine confirmation tools when used in the appropriate areas.

Bollinger Bands



Figure 2

In Figure 2, we have a chart with Bollinger Bands on it. In theory, when price pierces the upper or lower band, it should revert back to the mid-line. In real world trading which is what we practice in the Extended Learning Track (XLT) program, the chances of price turning after piercing the Bollinger Band are greatest when you also have price support or resistance. In the example above, price pierces the upper band and continues higher until it reaches price resistance. It turns lower at price resistance for a low risk short entry. Again, it's not that we don't want to use the Bollinger Band, it's that we don't want to just use it in and of itself. Your trading can be so much lower risk, higher probability, and higher reward if you incorporate real support (demand) and resistance (supply) into your analysis.

Fibonacci Retracement Lines



Figure 3

Figure 3 is an intraday chart of RIMM, a popular stock in the XLT program. After the move higher in price, astute traders would look to buy when price declines back to support but again, what is your definition of support… For the trader who uses Fibonacci retracement lines solely as support, for example, they have a choice of five different lines to choose from as prices decline. For the trader who incorporates real support (demand) analysis into their Fibonacci analysis, they would likely choose the 50% retracement line as that is the level that lines up with real price support.

While I could use example after example, I think you get the point. Trading is competition at its finest. When you push the button to buy or sell, there is someone on the other side of your trade or investment hoping to take your money from you. Who will end up getting paid in that trade depends on who has analyzed the market based on objective information. The goal is to attain an edge greater than your competition. Around each corner is another trader getting smarter, another Bernie Madoff, and another market maker or stock broker trying to sell you something for a price that they know is too high. Those that attain the needed edge in market speculation will get paid from those who don't. That's life.