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Chuck LeBeau - Indicators Are Not Systems

Technical indicators are best thought of as being 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" the value of any indicator depends on its application.

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Greg McKenna
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590 views

Chuck LeBeau - Indicators Are Not Systems

Technical indicators are best thought of as being 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" the value of any indicator depends on its application.

Uploaded by

Greg McKenna
Copyright
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We take content rights seriously. If you suspect this is your content, claim it here.
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Australian Technical Analysts Association

This document was downloaded from the ATAA Document Library www.ataa.com.au

Indicators Are Not Systems


Chuck LeBeau

One of the popular topics often discussed on trading forums and web sites 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. 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. Rather than saying a specific indicator is good or bad, we should hold the view that indicators are tools for solving specific trading related problems. For example, one indicator may be an excellent way to solve a particular problem, but 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

Copyright Chuck Le Beau. Do not reproduce without permission.

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. Perhaps my book Technical Traders Guide to Computer Analysis of the Futures Markets (co-authored with David Lucas) contributed to some of the misunderstanding about indicators. As you may recall, in this book 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 set-ups that define market conditions prior to entry, and to using indicators that can help us improve our exits. 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 adds 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 its possible effectiveness at the assigned task.

Copyright Chuck Le Beau. Do not reproduce without permission.

Charles Chuck LeBeau began trading his first commodity system in 1963 and has been an active systematic trader in stocks and futures for more than forty years. He is the coauthor of Computer Analysis of the Futures Market (McGrawHill, 1991), which is considered to be a classic work in technical analysis that is now published worldwide in seven languages. He has recently retired to his home near Sedona, Arizona where he spends most of his time playing golf and writing his new book about exit strategies. He can be reached at [email protected] This article originally appeared in Tharps Thoughts Weekly Newsletter published by Van Tharp (www.iitm.com).

Disclaimer: This document is provided for educational purposes only and is not intended as advice. It does not necessarily reflect the views of the ATAA. Readers must always assess whether the information provided is correct and whether it is suitable for their personal circumstances, and if necessary obtain professional advice.

Copyright Chuck Le Beau. Do not reproduce without permission.

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