Indicators and Edges: The Introduction

This post will serve as the introduction for a series of posts which will likely span several weeks or more.  When I’m finished, I hope that the series will serve as a reference of sorts for the newbie/rookie trader who seeks the aid of indicators when making trading decisions.

The Why…

When I started trading, luckily I did not buy into the indicator craze, as I am somewhat sceptical by nature.  However, there may be many traders out there who want to use  the standard indicators, and hopefully, late at night, they are wondering, “Do they work as described?” I will attempt to answer this question, and will do my best to answer any more questions that are generated from the testing results.

The most important thing to realize is that the professionals have already run these tests, and they may or may not be taking the other side or your trades.

Of course, in the vein of Michael Stokes’s post, this information has likely been covered in various books, such as this one. However, there is a great deal that I stand to gain from running these tests myself, mainly from familiarizing myself with the intracies of the indicators as well as the experience that will come from coding the backtests. So yeah, there is something in it for me, too. I do hope though that this format, being interactive, can be more beneficial than a chapter in a book.

The How…

In this series I will test indicators several different ways.

First, we will look at what happens the day after an indicator gives a buy/sell signal. For example, what happens when the MACD crosses and gives a buy signal? Is there any edge the next day? Finding an indicator with a large short term edge can be a gold mine. Imagine an indicator that provides an average trade of 0.5% over the next day and has five opportunities per day. The point is, if an indicator provides a large edge and enough opportunities over a very short time frame, that is where money should be placed (assuming you have a short-term time horizon).

Secondly, we will examine the edge provided by an indicator looking out over X days. For example, when a MACD cross occurs, what is the average profit per trade 20 days later?

Finally, we will look at indicator settings that have given the best results over the last fifteen years or so. I think what we will find is that the settings currently being used are likely not even close to being optimal. Maybe not. We’ll see…

The When…

As mentioned in the introduction, this will not be a series that can be finished quickly. Each indicator will probably need three or so posts to flesh out the results as described above. I plan to get started this week. The first indicator to be examined is the very popular Moving Average Convergence/Divergence, otherwise known as MACD.

Be on the lookout for this upcoming post: Indicators and Edges: MACD.

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