Logic, Rules and Indicators
Logic, Rules and Indicators
When it comes to entry points into a trade, most traders are always looking for the entry to offer confirmation and very low risk. The trap they run into is thinking they can have both at the same time. I often write about the supply and demand concept which offers the low risk entry but gets you into the market before the big turn in price happens which means confirmation comes after entry, not at the time of entry. Most traders are glued to indicators and oscillators because they offer plenty of confirmation and that's fine if you use them correctly. The issue is that many traders take each conventional buy and sell signal an indicator produces and that can lead to trouble. For those new to trading, the following information should provide a good foundation and some structure when using indicators and oscillators and how they work best with price. For simplicity purposes, let's use CCI (Commodity Channel Index) to explain some safe guards and rules but be assured, these rules and logic are equally applicable among most indicators and oscillators.
CCI attempts to measure the variation of a stocks/futures price from its statistical mean. High CCI values show that prices are unusually high compared to average prices. Low CCI values show that prices are unusually low compared to average prices. The CCI is an oscillator that fluctuates between ñ 100 and + 100. Prices are considered overbought when CCI moves into + 100 territory. Prices are considered oversold when CCI moves into ñ 100 territory.
The CCI shows over-bought and over-sold levels of ñ 100 and + 100. CCI extremes correspond to turns in price as seen on the candlestick chart. The turn in price in any market is where a trader obviously wants to buy and sell. However, if trading were as easy as taking these automated buy and sell signals, everyone would be making easy money, but that's not how it works. When using an oscillator like CCI (or RSI, MACD, Stochastics, and so on), it is important to take into account two things we teach and preach at Online trading Academy: Trends and Support (demand) and Resistance (supply).
Figure 2In an uptrend, the ideal use for CCI is to help identify low risk buying opportunities when CCI produces readings of ñ 100 or more. The upward slope of the 20 ma helps show us the prevailing trend is up.
In an uptrend, the CCI can produce readings of + 100 or more, but is of little use in identifying tops or potential turning points for a short entry. These readings should be ignored.
In a downtrend, the ideal use for CCI is to help identify low risk shorting opportunities when CCI produces readings of + 100 or more. The downward slope of 20 ma helps show us the prevailing trend is down.
In a downtrend, the CCI extreme readings of + 100 or greater lead us to shorting opportunities while we ignore the extreme oversold readings when the trend is down. In a strong down trend, all the oscillators will remain oversold, producing buy signals that can get you into real trouble if you buy when they occur.
After a breakout, prices had a sharp sell-off into support (demand) which was also the origin of the breakout. This was accompanied by a very extreme CCI reading of ñ 166.67, offering a very low risk / high reward buying opportunity, in the context of an uptrend and at support.
Setup: Rally to resistance within a down trend.
Trade Enhancer: CCI very overbought.
Action: Sell at resistance when CCI is overbought. Stop is above the high of the pivot (reversal candle). This is low risk / high reward trading.
We use CCI to identify novice buying and selling in the wrong areas and at the wrong times. Proper use of the CCI in conjunction with Trend analysis and Support (demand) and Resistance (supply) analysis can help stack the odds in your favor when forming a trading decision and trading plan. It also helps take emotion out of trading as it allows us to view objective information at times when trading emotions are tested to the fullest. Obviously, however, an indicator based entry point doesn't get you in the market at the turn in price like supply and demand will, it gets you in just after price has turned so the trade off for low risk is confirmation. Again, you can have a low risk entry or you can have confirmation; you can't have both.
Have a great day.
- Sam Seiden
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