The holy grail of indicators

With that title, I am sure you are going to read this post to the end! If you have no time, the summary is: the holy grail just does not exist but it is worth searching for it, for the path is more important than the actual indicator!

If you are looking for the best ever indicator, you can hardly start from a blank page. You need inspiration, you need to get your brain on invention steroids! So, the first thing to do is to consider what is available on trading platforms and make a strength / weakness analysis. you need to get a deep understanding about how the indicator is built, how it behaves under different market conditions, play with parameters and multiple securities like index, stocks, trackers, …

Let’s look at MACD or Moving Averages Convergence /Divergence. I will not explain here the background, but show one graph with 2 different parameter settings.

See? One is smoother than the other. The timing of signals is the same but the eye likes second one much better. Meaning also, if you make it part of trading system fully automated, you will have less noise to manage!

MACD is a trend indicator, therefore it performs quite poorly in horizontal markets. What about a momentum indicator?

This one tells you you are in an uptrend when positive and when it goes green below 0, it may be a counter-trend trade opportunity. It looks good to the eye, not perfect as there are false signal, but looks fairly good. Of course, some back testing would be needed to validate the impressions!

Now if you are looking for the grail of indicators, here is what it should do:

  • It should tell you what is going up in higher time frame (e.g. in weekly for a daily chart). Because it means you have some good move on-going, it is not just noise in current time frame
  • It should be capable to anticipate market turns, through divergences or hidden divergences (in direction of the trend)
  • Signal should be timely, not too early and definitely not too late
  • You should be able to see and professional are doing versus all other market participants
  • It should be smooth and easy to read
  • The number of false signals should be reasonable
  • The signal should be profitable as often as possible. Refer to previous article about winning streaks.
  • Please add here you own requirement: …………………………………………..

A way to look at higher timeframe in a single chart (holy grail surely means only one chart!) is to use synthetic bars. This has been introduced by Cynthia Kase in her book: ‘Trading with the odds’

The idea is to to calculate MACD as if on a weekly chart but we do the calculation each day, so we have the information we want before the week is closing. MACD on weekly chart is usually used as one-bar indicator on histogram: when it changes color (goes up after going down in negative territory), it is signal to buy. Just look! Green arrows point to buying opportunities in weekly chart, sometime 3-4 days before end of the week!

There are hundreds of indicators available on the markets. Try to make sense about the most common ones, discards those that are complete nonsense, consider those that work as promised by their author (I have not found any divergence for long time on accumulation/distribution) and continue your trip! It gives food to your mind!

Your next question is of course: did I find the holy grail? I wished! Please remember we are trading prices, not the indicator! My indicator tells me where professionals enter after market bottom (red circles in counter trade), has plenty of divergences, has zero crossings or bumps (smileys) to indicate entries in direction of trend. But it is not perfect, get some false signals from time to time (because the professionals are wrong ;-), jsut kidding of course)

Of course there remains the need for risk analysis (volatility and position sizing, price objectives).

Until next time, trade safely and don’t take useless risks with virus!

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