Many traders fantasize about a trading system or technical indicator that can capture every zig and zag in the market. A very intoxicating thought, but sorry to be the bearer of bad news, it just isn’t so. Please don’t shoot the messenger!
Despite all the marketing hype all over the internet, no one system or indicator can do it all.
Have you ever tried to tune-up your car? Well if you did, you certainly didn’t use just one tool. Depending on the car, it took a whole bunch of specialized tools to get the job done. Not only that, you also need to know how to use the tools and when to use them.
Trying to pull profits out of any market on a regular basis is the same way. It requires a lot of specialized tools and for most traders, technical analysis provides our palette of tools.
Since the market can zig and zag at any time, we need a “Trading Tool Box” full of technical analysis tools.
For example, when the market is in a trading range, then oscillating indicators work very well.
However, when the market is trending strongly then oscillators aren’t worth a pile of beans. When the market is trending then things like moving averages are one of the ‘tools of choice”.
Getting back to the car analogy… When your car isn’t running properly, your mechanic pops it on a diagnostic machine which quickly tells them what the problem is. Then it is simply a matter of pulling out the right tools and parts for the situation.
When it comes to trading, the bottom-line is if you can’t diagnose the current market, then chances are you will be ill prepared and lose money.
In this post I am going to share a strategy that will help you get a much better read(diagnosis) on the market. This in turn will ensure that you use the proper trading system and technical analysis tools to get the job done.
System Development Technique 1
You need to find the market or time-frame that best suits your trading system.
Let’s use my Trade Secrets program as a real example. In this program I like to look at a particular candlestick pattern, the Stochastics Indicator and a series of chart formations. This creates a unique system that helps me capitalize on a lot of trades in all markets including forex, futures and stocks.
Even though I can find countless trades with this program, it doesn’t mean that it will work equally well all the time in all situations. Let me explain…
Lets say I want to day trade stocks. I may look at a 15 minute chart of Microsoft and notice there are not many situations where my system sets up. By simply switching to say a 5, 10 or 30 minute I may find some great setups. If however Microsoft for whatever reason doesn’t seem to produce a descent amount of trades for my system, then I will simply look at other stocks for better opportunities.
Let’s look at an example in forex trading. Say you have developed a strategy that looks promising. You will need to go through a lot of currency pairs to see which ones contain the most setups as dictated by your trading methodology.
Let’s take a look at one more example. Say you are a position trader and use daily charts. If you are not finding many trade setups, then you may all of a sudden find a whole supply of them by looking at a 2 day or weekly chart. You may even want to jump down to a 4hour chart to get a different point of view.
Once you have found some good candidates you need to proceed to…
System Development Technique 2
Having an ample amount of valid trade setups for your system is only half the equation.
You need to trade markets that have follow through! In other words once they trigger your entry, they start moving with a lot of momentum in the correct direction. I can’t emphasize this enough, momentum is what puts money into your account. Without it you will eke out small profits and get whipsawed in choppy market conditions.
Trades that have a lot of momentum will show price bars the are making mostly higher highs and higher lows in an up trend. In a down trend you will have mostly lower highs and lower lows.
In a strong uptrend, the bars will also tend to close in the upper third of their range. In a strong down trend they will mostly close in the lower third of the bars range.
When looking at my candlestick charts I will also want to see a predominance of green candles in an up trend and a lot of red candlesticks in a down trend.
So to pull this all together…
Step 1: First find a suitable time frame in which there are ample trade setups based on your strategy
Step 2: Make sure that when your trade is triggered you see signs of strong momentum and follow through
If you do not see signs of strong momentum, then odds are the market is going to be choppy and you want to avoid these like the plague as they are much harder to make money in. Choppy markets also cause you to get stopped out way more.
By doing the above steps you will end up with a small group of “cream of the crop” stocks commodities, currencies etc.. This way you will spend all your energy entirely focused on markets that will give you the greatest odds for success.
One last thing to note… Markets change so you need to constantly evaluate whether your favorite stock, currency, commodity is still behaving the same way. If it isn’t then you need to look for a better time frame or move to a new market.