Takeaway 3

April 15, 2021

4:45 - One indicator to rule them all? 

I haven’t talked about indicators so far in this blog. Let us take a step back 

When you are looking for trades or investments, there are two types of analysis. Fundamental analysis, and technical analysis. 

Dependent upon what you are doing, whether it is short-term trading, or long-term investing, you should put a different amount of effort into each of the two types of analysis. That is, for investing one kind of analysis is more important than the other, and vice versa for trading.  

In my program, I also show you step by step what to do in order to do a fundamental and technical analysis to answer key questions before making any investment or trade. 

One aspect of technical analysis is utilizing indicators. 

An indicator does not give you any clear answer. As the name suggests, it is just an indication of something. 

Just like time is an indication of the number of cars on the road, an indication in technical analysis is an indication of for example the price development. 

If you are planning a ride, would you prefer to leave at 8 o clock in the morning, or at 11 when the rush is most likely over, but before it begins again in the afternoon?  

Even though it is likely that there are fewer cars and thus no traffic jam at 11 o clock during the day, as compared to 8 in the morning, it is just an indication. There might have been an accident on the road, causing a traffic jam. Your watch will not tell you that, the time is just an indication 

In the same way, we have indicators in the financial world of investing and trading as well. 

Imagine a woman taking her dog for a walk. The woman represents the overall, long term. She is likely to move in more or less straight lines. There are indicators to spot the overall trends, such as moving averages. Alex trades with these indicators. 

The dog, however, will likely move back and forth across the path during the walk, given its leash allows it to. When the dog spots or smells something interesting, it makes a rapid move to the side. Indicators for this short-term movements is what Alexander Elder refers to as an oscillator. They are useful for identifying turning points and Alex trades against them, that is in the opposite direction. 

The summary is that there is no indicator to rule them all. Different indicators are used for different purposes and in different situations.  

Alex moves on and mentions three rules for using indicators 

  1. Exponentials are better than normal averages. 
    A common indicator is the moving average. It tells you what the average price has been in over the past period, for example, the last 20 days
    Alex explains why he prefers the exponential moving average over the standard moving average. Exponential averages put more weight on the most recent days, as compared to the normal average which weighs all days equally.  
  1. Watch related markets
    an indicator is more reliable if it is confirmed by a similar indicator in a related market. 

If the moving average of the past 20 days of The Walt Disney Company is up, and the same is true for Sony Media Entertainment, it is a sign of strength 

  1. You need a bigger fishing rod to catch a bigger fish
    When we get a specific indication, it is called a signal. Signals in longer time frames generally lead to greater price movements. It is possible to look at the price development of investments and trades in a weekly summary, daily summary or hourly summary, and many more time frames.  

Signals in longer time frames generally lead to bigger price movements. Weekly charts beat dailies, which beat hourlies. 

If you are going to start using indicators, start with a few of them. Use both trend-following indicators and oscillating ones. Learn to interpret and read them correctly before adding more indicators.

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