Chuck LeBeau's System Traders Club
BULLETIN Number 19 Jan 14, 1999

Indicators Are Not Systems

In addition to participating in the discussions on our own FORUM page, we spend a great deal of time monitoring various newsgroups and web sites that deal with trading and technical analysis. One of the popular topics of course is the relative value of various technical indicators. For example someone might ask: "Which is better, MACD or Bollinger Bands?" Or simply: "Which is more profitable: ADX or CCI?"

The implication of these questions is that indicators are being confused with trading systems. We think it is important to understand that technical indicators are best thought of as being merely small parts of a system and not systems in and of themselves. A typical comment like: "I tried Indicator X and found it was worthless." makes no sense at all. Or, "I tried ADX and found that it was excellent." These statements imply that an indicator was tested as though it were a system.

In our eyes there are no good or bad indicators. Indicators are best thought of as tools for solving specific trading related problems. One indicator may be an excellent way to solve one particular problem and the same indicator can be of no value in solving a different problem. The value of any indicator depends on its application. As system developers we must avoid sweeping judgmental evaluations that might conclude that indicator A is better than indicator B. Our task is to learn which indicators can best solve particular problems and make certain that we apply whatever indicator is appropriate for the task at hand.

Every indicator has its strengths and weaknesses depending on how it is applied. For example we have found that moving averages are poor entry triggers but excellent directional indicators. The fact that the five-day moving average is above the twenty day moving average may be a reliable indication that the trend is up but it doesn't mean that we want to buy immediately. On the other hand an upward range expansion might be an excellent entry trigger but have no value in telling us the direction of the underlying trend. If we combine these indicators so that we go long in a market where the five-day moving average is above the twenty-day moving average immediately upon an upward range expansion, then we are getting into the construction of a viable system. However if we bought or sold every range expansion or 5/20 moving average crossover we would quickly conclude that these indicators had no value.

David Lucas and I are presently working on a second edition of our book, Computer Analysis of the Futures Market. Perhaps our original book contributed to some of the misunderstanding about indicators. As you may recall, in our first edition we tested many popular technical indicators as entry triggers and concluded that almost all of them were useless for this task. At that time most technicians approached technical indicators as though the only purpose for an indicator was to be a stand-alone entry trigger. After many years of continuous analysis and research we have learned that indicators have many different applications and that they should not be judged or compared solely on their value as entry timing techniques.

We have learned that indicators should be viewed as tools and not systems but we also need to understand something basic about using tools. If we tried to hammer a nail with a saw we might discard the saw as a useless tool. If we tried to cut a board with a hammer we might conclude that a hammer was a useless tool. Once this is understood our task is to learn which trading tools can be used to solve which trading problems and quit trying to find, buy or invent the best possible indicator. The "best" indicator is simply the one that solves the immediate trading problem at hand and that problem rarely requires another entry trigger. Instead of looking at indicators as entry triggers we must give more thought to using indicators as setups that define market conditions prior to entry and to using indicators that can help us improve our exits. In our opinion the world of technical analysis already has more indicators than we know how to use and the recent proliferation of indicators without a purpose merely add to the confusion. I would suggest that anyone planning to introduce a new indicator should clearly state its intended purpose and application and show some test results that indicate is possible effectiveness at the assigned task.

In terms of need and practical value I would most like to see an indicator that would help in selecting which markets are most likely to trend strongly in the next few months. I suspect that there might be some merit in an indicator that measures and incorporates both volatility and directional movement. If there are any mathematicians among our members that would like to have a crack at developing such an indicator please keep me advised of your progress.

In the weeks to come we will try to share some insight on which indicators we think work best on specific problems that we typically encounter when building a trading system. Our knowledgeable members can also help. If you have found any indicators that work well on particular problems please share some of your knowledge with us privately by e-mail or publicly on our Forum page. Here are just a fewexamples of what would be helpful: We are looking for setups that indicate sideways markets. We are looking for setups that are predictive of increasing volatility. We are looking for exit setups that tell us when to tighten our exit stops. We are looking for an indicator that might be helpful on telling us how soon to implement a break-even stop. We are looking for short-term patterns that are good entry or exit triggers.

Or perhaps you have isolated a problem that we have failed to mention and have an indicator that solves that problem. In a nutshell, what we are looking for is a matching of indicators with the problems that they can solve. We don't want to hear that the X indicator is a great indicator or that the X Indicator is better than the Y Indicator. Let's start sharing information about indicators on a very task specific basis and we will all become better traders.

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WEBMASTER REPORT

Self Moderating Classifieds Up and Running

Last time I mentioned that we were working on a new version of our Classifieds Section and it is now available for use. Some of you have found it on your own and have already taken advantage of it. The new Classifieds are a subtopic on our Forum and you can enter your ads as you would any other forum post. We suggest that you take advantage of the email linking and enter your name in the username box and your email address in the email address box so that people can get in touch with you easily. There are some basic rules and instructions to read when you get to the page and we hope that you take advantage of this resource.

Go here for Classifieds

We are also in the process of updating the Combined System Equity page to the end of the year 1998. We should have this ready at some point in the next week or so.

As always please feel free to email me with comments, suggestions, or questions regarding the website.

David Elden
[email protected]

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That's all, Good Luck and Good Trading

Chuck LeBeau

[email protected]