trends may change, but they did very little to help me consistently time
those changes accurately enough to make money. Instead, these indicators
caused me to form counterproductive opinions.
Three examples that show how opinions and indicators can be
dangerous:
1. Opinion—MACD Example:
Let’s say you have bullish divergence in a moving average convergence/
divergence (MACD) oscillator, and you now have an opinion in
your mind that prices should change from the current downtrend to an
uptrend.
So, you look for a reason to go long, an entry signal. One comes
along and you take it. You think to yourself that you would not have
normally taken that signal if you did not see bullish divergence, but
with bullish divergence you feel you should. Prices then continue
downward even lower and the bullish divergence remains bullish so
you stay with your long position.
“. . . Can’t go much lower . . .” you say to yourself. It does go lower
and now you’re worried but you do not want to sell and take the large
loss, so you hold on. After all, the MACD divergence is still bullish, but
not as much as before.
Soon the divergence turns into no divergence and instead the trend
down becomes apparent, and you now must sell out. You feel depressed,
frustrated, and betrayed by your MACD oscillator! If the oscillator
had not been there, you would never have taken the trade to
begin with.
2. Opinion—Stochastic Example:
You get a trading signal to go long, but this time your stochastic
oscillator indicates that prices are overbought already, so you do not
take the long position. The so-called overbought stochastic oscillator
formed an opinion in your mind not to take the trade. Now you sit
there and watch a great uptrend developing right before your eyes and
the stochastic oscillator remains overbought during the entire 10-point
uptrend. Had you never looked at the stochastic oscillator, you would
not have had an opinion, and would have gone long.
3. Opinion—MACD Example:
You see bearish divergence on the MACD oscillator, so you form
an opinion that the uptrend is ending and now you look to get out of
your long position right away. You then use a trailing stop and exit
the market—only to find prices reverse and go higher and the MACD
oscillator turn bullish. You are left scratching your head.
Examples of how opinions distort reality could go on and on, but you
get the idea. And the idea is that oscillators form opinions, and opinions are
not in the best interest of the successful trader. Instead, with ART, you will
learn to listen to what the market is actually saying through price action
and volume.
Strive to create an environment without opinions. That means avoid
reading financial newspapers, watching financial TV, or listening to financial
news in any form while trading.
News programs form opinions, trading oscillators form opinions, and
market analysts form opinions. We do not know how the markets will react
to news and financial recommendations. If we think we do, then we are
forming an opinion about the news.
How many times have companies come out with great earnings and
sold off right after the announcement. And when the market does sell off,
the news commentator comes out and says “. . . the stock had run up already
in expectation of the good numbers and then sold off. . . .” If instead
the stock continued upward, the news commentator would say, “. . . good
earnings drove the market upward. . . .” News commentators operate on
20/20 hindsight. We do not have this luxury.
OVERBOUGHT AND OVERSOLD CONDITIONS
The Market Itself Is Never Overbought or Oversold—Think about It
Markets work to bring price in line with supply and demand. Markets are
perfectly efficient. If supply always equals demand, then how can a market
be overbought or oversold? It may be expensive, but expensive can be a
relative term.
For example, suppose you purchased a painting by a currently unknown
artist/painter for $1,000. The next week your artist/painter gets reviewed
in a famous magazine and his work is now nationally recognized,
so your painting increases in value to $1,500. Some say that your painting
is too expensive or that prices are now overbought because it went up in
value too quickly in just one week.
What if the next week a famous collector buys a similar painting by the
same artist/painter for $4,000, and now the value of your painting increases
to $3,000!
All the indicators said that it was overbought at $1,500 because the
price went up too high in a short period of time. The reality is that because
of supply and demand, prices are exactly where they should be—regardless
of the reasons! There is no such thing in an efficient market as overbought
and oversold. Prices are where they are because that is where they are
supposed to be!
INEFFICIENT MARKETS VERSUS EFFICIENT MARKETS
There’s a great debate between academics regarding the issue of efficient
markets versus inefficient markets. There are traders who believe that just
because they make money in the markets, the markets are therefore inefficient.
Their belief is that they exploit the inefficiencies of the market in
order to make money.
But, aren’t they just adding to the efficiency and liquidity of the market
with each and every trade they make? For every one of those traders who
made money in the market, there is another trader on the other side of the
trade who lost money. Now, that is efficient. The bottom line is the markets
are efficient no matter how you look at it.
SUPPLY = DEMAND
When supply equals demand, both the seller and the buyer disagree on
value, but agree on price. This is important . . .
When this happens, it is a truth in the marketplace. The amount of
supply and demand occurring in the market is called volume. That also is
a truth. Both price and volume are absolute and are truths of the market
because they are not distorted. (Indicators used in technical analysis often
distort price and volume.)
Read More: DANGEROUS OPINIONS AND INDICATORS: A WORD ABOUT MACD AND STOCHASTICS
