Note from Tim: Dutch originally wrote this post a few years ago for the blog, and he asked me to dust it off and repost it. So here ya go:
This post may offend many and that is not its intention. This is a think piece I have been formulating in my mind for quite some time now. Its purpose is to get you to think about your trading methodology(s) and setups in a critical light.
To my way of thinking, traders who utilize technical analysis all fall into three broad groups (traders who use purely fundamental analysis are excluded from this type of grouping).
In this group I include Elliot Wave traders, Gann traders and astrological traders. These traders trade in the future. Based on what they say may happen and some go as far as to say what WILL happen. When a trade is a failure, they use misinterpretation of past price action as the excuse for the failed trade. It seems that Elliot wave traders (mostly sellers of the system) are in a constant civil war as to “correct” interpretation. Gann followers can spend their entire trading life searching for his “missing” piece.
A lot of legend has been created around WD Gann, promulgated by promoters of his methodology. WD Gann was prolific in his writings and covered a multitude of areas. Regardless of what happens next, some part of his work can be given credit for “calling” the “move.” Too bad we lack foresight to know which one! He is also been credited to have died with a tidy fortune due to his trading. Interviews with his son (who happened to have been in the banking business) revealed that he died in modest means and made the bulk of his money promoting his ideas over his life time. The foremost (and longest being tracked) in the astrological trading group is Arch Crawford. In over 25 years of his trading service, he has had flashes of brilliance. However, according to Hulbert, his record, overall, has well under performed the market during the long period tracked. Prognosticators rely on interpretation of price. So much for the prognosticators.
In this group I include all those traders who rely on lower studies (MACD, STO, RSI, and hundreds of other lower case studies) and upper case studies (such as Bollinger Bands, Keltner Channels, fibonacci ratios, etc.). these traders trade in the past as ALL those studies are based on market driven price information in the past viewed through different lenses. Add to that, very little, if any, are NOT subject to interpretation and therefore, not objective information. What do I mean by that? They all have variables within them that can be “adjusted” or “tweaked”. IF that is the case, then it cannot be objective information you are viewing. Here are some examples:
Number of variables in trend tools: MACD=3 and ADX=3.
Number of variables in retracement tools:
a) Percentage retracements: Fib ratios=4; Harmonic ratios=2; Arithmetic ratios=2
b) Over bought/oversold indicators: RSI=3; Socastic oscillator=4
Each input can be changed. So let us say, you put together a trading methodology based on these. Here are some example combinations and the variables involved (Dreamer traders LOVE to use these in combination!):
System 1: Moving Average=1 and RSI=3 for a total number of variables of 4.
System 2: MACD=3 and Stocastics=4 for a total number of variables of 7
System 3: Moving average=1, ADX=3, Fibs=4 and RSI=3 for a total number of variables of 11.
If you can massage the variables, then what you see is NOT objective information. This is the problem with the search for an indicator system Holy Grail. The case CAN be made for a ONE variable trading system. However, once you introduce more than one or two, the probable variations become too large to test. Too many moving parts that are interconnected. The last system would be near impossible to stress test successfully. There are simply too many moving, interconnected, parts to have any confidence that you have hit upon the “correct” variable values. This type of analysis leads to the worst cases of curve fitting historical market data as well and that can be absolutely devastating to trading capital.
A brief word about fibonacci retracement levels. Numerous studies have shown that they are no better and no worse than any other set of ratios. No magic there, either.
In summary, I would suggest that the trader select measures of trend and retracement that have built-in protection against you fiddling with them. The best measures with this built-in protection are ones without parameters or adjustable variables. The best ones are objective and independent of you. The best ones are fixed and NOT subject to any interpretation. Adjustable parameters are just plain unreliable for making trading decisions. This brings us to the third type of trader.
In this group I include Market Profile traders, Pivot traders, single trade setup traders and to a lesser extent, Chart Pattern traders. Chart pattern traders are a different breed and exist in both Dreamer and Pragmatist camps. The visualization of a pattern is subjective and interpretive in nature but can, if correctly used, create a pragmatic conclusion: it either works or it fails on such a manner that is not subject to interpretation in a trade.
The Pragmatic trader trades in the now. Not the future or the past. There is no room for any interpretation. It either works or it fails. Support/resistance holds or it does not, etc. The idea here is to select objective and fixed measures for determining trend direction and retracement levels. There can be NO interpretation in their use. A 12 year old must “interpret” the same way you would or you must discard it! There is no wiggle room and there are no shades of grey here at all. It must be fixed. Simple. It either IS or it is NOT based on price NOW. This can be historically tested without problems. You can determine expectancy for what you are doing and have confidence in that expectancy.
Conclusion And Something Else to Ponder
Before any devotees of any methodology get all up in a dither based on my views and observations in any of the above material, here is something for ALL traders to consider.
Could it be we are ALL placebo traders? My intent here is not to tell any trader how they should trade. Personally, I am a pragmatic trader as it has much fewer “problems” and resonates with ME. If you are a successful trader (defined as a trader who consistently extracts capital from markets and has a positive, upward equity curve) regardless of methodology use, could it be that we are using our chosen methodology as a placebo? Are we using our chosen methodology to give us the courage to actively engage markets?
Could it be that the successful trader is just a superior trader in spite of the chosen methodology? Could it be that the successful trader is NOT giving himself the credit deserved for being that superior trader and giving undo credit to his chosen methodology? This then leads into the field of trader psychology and away from methodology. This is an area, I believe, deserves some serious thought and consideration. Peace, my fellow traders and may your equity curves trend ever higher!
Yours in the never end quest of the trading edge. The Market Sniper.