Planes, Trains, and Automobiles

…One of everybody’s favorite John Candy movies of all time. When I was a teenager, I had a very small part in another one of his movies and got to meet him. He was a big funny guy just like I expected. As funny as the movie is, there is a real story in it that all traders and investors need to be aware of. I go through periods where I travel quite a bit through air, cars, and occasionally the Tube in London and elsewhere. Air travel can be tricky and draining because of airports and weather you and I have no control over. Being an Executive Platinum member, knowing all the short cuts, and tricks with lines and special seating, the experience can still be long and draining at times. Overall, I do enjoy air travel. Sitting back with no access to a phone is quite relaxing. Driving to your destination is another story. Long airport lines are replaced by stand still traffic, road raged drivers, and icy roads if you live in Chicago like I do. You are also now the pilot so there is much more responsibility than flying. However, heated seats and a good sound system make driving a pleasure these days. Train travel is something I have not experienced much but when I do, it is typically a packed tube in London or the subway in Manhattan. Wherever you’re going, whether your destination is Florida or the North Pole, a plane, train, or automobile can get you there just fine.

Just like travel, there are many ways to reach your desired destination in trading. The chart below shows a recent short term income trade. This small time frame supply level was well placed on the curve. Our “odds enhancers” exercise suggested this was a high probability opportunity as well.
When price rallied up to our supply level for a short entry, that told us these were very novice buyers buying after a rally in price and into a price level where the chart told us supply exceeded demand. Price proceeded to fall to our target and the trade was complete. All the information we needed to identify and take advantage of this low risk and high reward opportunity is clearly seen with price and price alone. Ultimately, all that matters is knowing where the significant buyers and sellers are in a market and price does a fine job of showing us that.

DAX – Short Term Income Trade: 7/24/13

Some traders however are either not comfortable using only price action analysis or they desire more confirmation to take a trade. For this, people tend to use indicators and oscillators as the confirmation crutch. Let’s take a look at the same trading opportunity only this time, lets add Bollinger Bands.

At the time of entry for our short position, we see that price actually touches the upper Bollinger Band suggesting an overbought condition for this trade. Price touching the upper band and reaching an objective supply level with a large profit zone below, this suggests higher odds.
Adding Bollinger Bands to this trading opportunity makes the trade more attractive and also points out a key ingredient when using Bollinger Bands. Don’t just sell short because price is touching an upper or lower band. Take action because price is touching an upper or lower band AND price has reached a supply or demand level. In the Options XLT for example, our options expert Eric Ochotnicki calls this setup an “All Star” setup.

Lets again look at the same shorting opportunity and add the Commodity Channel Index (CCI).
This is an overbought (+100 or greater)/oversold (-100 or greater) oscillator. Notice at the time of our short entry, CCI was giving an overbought reading, suggesting this was a high odds opportunity to sell short. Notice the overbought CCI reading I circled. This is in line with our short entry which makes CCI look attractive as a decision making tool. However, keep in mind that price does not turn lower because CCI is overbought, it turns lower because it has reached a price level where supply exceeds demand. As for using it for confirmation, it’s a decent secondary decision making tool. If CCI was our primary decision making tool here for entry and exit, we would have entered the trade early and maybe stopped out for a loss and we also would have taken profits way too early.

Last but not least, let’s add Slow Stochastics to our successful short term trade. Stochastics are a very popular overbought/oversold oscillator. The typical buy and sell signal are a moving average (red and blue lines) cross in overbought and oversold territory. Did the Stochastics sell signal line up with our price action sell signal, yes. Did the Stochastics buy signal line up with our price action profit target demand level, yes. Did we need Stochastics for this trading opportunity, no.

The most important point here is that while indicators and oscillators can assist in ones “comfort” level, these can’t be used as primary decision making tools. These tools don’t know anything about supply and demand and don’t consider it. It’s not that they are broken or don’t work. They are mathematically generated lines on your chart. The math is always correct. Whether that math leads to profits or losses in your trading account is the question most novice traders never ask and it happens to be the only question that matters. As John Candy showed us, there are many ways to reach our destination. Trading is only slightly different. While you can use indicators and oscillators as confirmation tools, if you are NOT filtering these buy and sell signals through real demand and supply levels, you are traveling east and west, trying to reach that North Pole, good luck with that. If you must use indicators and oscillators, go ahead and use them. Again, just make sure you filter those signals they spit out through proper supply and demand analysis. If I just repeated myself three times, it’s only because it’s so important and we at Online Trading Academy care about you and your financial well being.

Hope this was helpful. Have a great day.

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