(Mis)Use of Market Indicators

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  • on October 15th, 2010

I hate the term “indicators”.  To me, it implies prediction, and I try not to think of data in that way.  Call them clues, measures, tells, ingredients, puzzle pieces, whatever…we’re all looking for an edge and it’s not in reporting yesterday’s news but planning for what lies ahead.

Let’s go with “measures” for now, and place these items in their proper context.  Breaking price action into popular categories, we have the following general measures:

LEADING:             Momentum, Relative Strength, Volume

COINCIDENT:       Price, Volume

LAGGING:             Moving Averages, Trendlines, Volume

Let’s start with volume…I won’t get into too much detail, but I believe it can be a strong clue but can’t be pigeonholed into a leading/coincident/lagging role.  While the other measures are easier to categorize, volume can arrive before, during, or after a significant price move.  I think its use is warranted because of the potential to offer clues, but like options data its implications are the most “art-ish” of those listed.

So we’re left with the others…I’ve already discussed some of my favorites but my goal here is to stress the importance of placing them in their proper context.  What better way than to shine the light on someone who totally misused one of his homegrown favorites this week…me!

I’ve been sharing this tool I use that helps get me as close as possible to the best window for edge…a late leading but early coincident clue.  Best of all, right?  For me, it is, and has served as a great tool in identifying primary and secondary highs and lows.

As I share it, people have asked for details and I enjoy the sharing process…I’m confident in the message of this “tell” and when it speaks I listen.  But what about when it threatens to speak…should I listen? NO!!  Anticipating a front-running indicator is the worst way to use it.  First, what is the point of anticipating an anticipatory clue?  At the very least, if it’s truly a leading clue we can let it form an obvious signal before considering action.  Second, leading indicators may be necessary but are not sufficient for identifying trend continuation vs. reversal.  A powerful linear trend driven by other timeframe participants will blow through a host of so-called divergences as the feedback loop crushes the early reversal-callers.

After letting this measure keep me mostly unhedged through the past 6 weeks of bullish market action, my growing unease with the length of the rally had me looking for the big clue…a loss of momentum and relative strength.  As stated here, it takes either a significant anchor/pivot day in the rear-view mirror, or a week of lackluster readings amidst index highs, to trigger a signal from my favorite tell.  Yet here I was offering this analysis before either of those triggers were even possible.

So, confirmation bias got the best of me and I forced a hedge before its time had come.  A small hedge, but totally unnecessary given the fact that I KNOW I’ll act no later than in the coincident stage of indication.  I’m better at sharing my mistakes than my successes, and I hope someone out there can incorporate a little piece of my lesson and save themselves a buck.  Being early equals being wrong, and is as great a sin as chasing a death cross.

Quick read on breadth momentum:

Wednesday had the potential to be an inflection point, with half of my stock universe making a 21 day high.  So we finally got the necessary condition for an anchor/pivot day, but I was surprised that many of those highs were eclipsed on Thursday without the indices making a high.  So it’s still possible to get a reversal signal out of this structure, but only with a non-confirming index high or major dropoff in highs over the coming week.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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