“Those who have knowledge don’t predict. Those who predict don’t have knowledge.” Lao Tzu, Chinese philosopher, 6th century BC

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Sunday 13 January 2013

A SIMPLE CASE OF STOCHASTICS part 2

Keeping things simple in my mind always kept things clear, and why wouldn't it work in anything including trading the market.  I never stop looking for other ways to improve on my trading or analysis of the market but when the markets open I keep it very simple.

My uncle used to be the governor of stock exchange back in Asia, and I had proposed to him that I have found a system that works and it only involves only one indicator. What he said did not surprise me at all.  In fact it just confirmed what people are like in this profession.  And like they always say, you cant teach old dogs new tricks.  I suppose that it doesn't matter anyway since he's pretty successful in his profession and a good one at that.  One thing that convinced me to this day that this system works is that there are so many traders out there that give you their opinion and never listen to yours and yet they are the ones losing money.  The way I see it is, if your breaking even most of the time on your trades.. your way better than 80% of them out there.

The Stochastics is nothing new and nothing that hasn't been looked at by many traders.  In fact there are tons of indicators out there that can be used successfully, but I chose the stochastics because it has a ceiling, a floor and it also has your overbought and oversold line.  It also has enough volatility to trade whether its a weekly, daily, 60min, 30min, 15min, 5min or 1min.  But let me say this and I'm not the only one who have said this..  "The more trades you pull the more chances for mistakes."  Therefore I don't think trading in the 5min or 1min. is a good idea.  Unless you think you can beat your odds then go ahead be my guest.

People will always show you an indicator, and will always say.. "see its diverging, or see its bearish / bullish etc. etc."  What they don't tell you is if they picked up that signal at its lowest or highest.  Were they able to call it when it started / ended?

The key here is you need to base your signals with something else.  You need to  compare your analysis with a secondary signal.  Now here is where it gets interesting.  Ever get an analysis from someone who is comparing MACD to RSI or OBV to MAs?  Sure it sounds great coming out of their mouth but that just fluff.  I can't say I can tell anyone where markets are headed, but the best way to win in this market is to never SPECULATE or ANTICIPATE.  Always REACT.

As the great Jesse Livermore said:
"I never try to predict or anticipate. I only try to react to what the market is telling me by its behavior."

But its not in human nature to react.  We as humans always try and try to beat or out smart the market.  We want to out think it and we want to say we are the best.  But we are not..  I can say that there is only a handful of traders and analyst who can forecast the future, but even they won't completely reveal their secrets.  So don't expect to enter this profession and think everything will land in your lap.  My parents always told me that I only play the stock market because I want easy money.  I don't think I have worked hard ever in my life compared to having a fulltime job.  Not only do I have to do all the work, but no one pays me to do the work.  This is like working for commission if you make any profits.  Agree?

Anyway its very simple.  If you need to compare your indicator, you should always compare it with the same indicator.  What I mean is compare it with a different time frame preferably with 2 time frames higher.  Therefore if your using the 30min to trade then you should use the daily to compare with your 30min.  If your using your 60min then you use your weekly to compare.  There is no set rule for this.. and so long as your comfortable with whatever time frames you use is good enough.  I can tell you though that using this will help you find momentum or exhaustion in the stock or market depending on what your looking at.

I have said this many times.  I hope you can see through the metaphor as I try to make it more understandable.  Imagine a hammer and a nail.  Both hammer and nail are considered stochastics but the nail represents the higher time frame (lets say daily), and the hammer represents the lower time frame (lets say 30min.)  These two work hand in hand and they need each other to function.  When the daily stochastics moves, it moves due to the 30min.  There will be more movement on the hammer than the nail because it is whats driving the nail down.  Each time that hammer pulls back its called a RESET.  Imagine now that if your trend was down for example you would want to short the market.  Your Nail (Daily) shows a trend downwards.  Your hammer now wants to move this nail down and if the hammer is close to the nail it will have a hard time driving it down.  So what it needs to do is to pull back and reset itself so that it could get more energy to push that nail down.  The stochastics functions the same way.  If your short the market then you would need to look at the 30min to see where your stochastics is at.  You would not short the market when the 30min is at oversold even if it pushes down further because on a 30min basis it is limited to time and you might only get a few points out of it.  The best time is for you to wait for the 30min to pull back up to overbought and then confirm with your daily that it is still bearish, and only then can you go back in short.  Do this and be diligent, be disciplined and you will find that this is probably the best tool you can rely on.

MP

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