Thursday, November 24, 2011

Oscillator vs trending environment

Many traders, especially beginners, are drawn to indicators, hoping
that an indicator will show them when to enter a trade. What they don't
realize is that the vast majority of indicators are based on simple price action,
and when I am placing trades, I simply cannot think fast enough to
process what several indicators might be telling me. Also, oscillators tend
to make traders look for reversals and focus less on price charts. These
can be effective tools on most days when the market has two or three reversals
lasting an hour or more. The problem comes when the market is
trending strongly. If you focus too much on your indicators, you will see
that they are forming divergences all day long, and you may find yourself
repeatedly entering Countertrend and losing money. By the time you come
to accept that the market is trending, you will not have enough time left
in the day to recoup your losses. Instead, if you were simply looking at a
bar or candle chart, you would see that the market is clearly trending, and
you would not be tempted by indicators to look for trend reversals. The
most common successful reversals first break a trendline with strong momentum
and then pullback to test the extreme, and if a trader focuses too
much on divergences, she will often overlook this fundamental fact. A divergence
in the absence of a Countertrend momentum surge that breaks a
trendline is a losing strategy. Wait for the trendline break, and then see if
the test of the old extreme reverses or if the old trend resumes. You do not
need an indicator to tell you that a strong reversal here is a high-probability
trade, at least for a scalp, and there will almost certainly be a divergence,
so why complicate your thinking by adding the indicator to your calculus?

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