Technical Indicators: One’s Just Not Enough

Years ago, I conducted a series of interviews with technical analysts. I was fortunate to meet some very successful technicians.

Some were older and had been on Wall Street for over 50 years. Others were new to the industry. There was a key difference between them.

Older practitioners focused on charts. They talked in terms of patterns they spotted in the price action.

Younger analysts, on the other hand, worked with quantitative models. These models sometimes included simple technical indicators.

Both of these approaches have merits, but there’s no reason why you can’t use them together. In my experience, combining the old school and the new school of TA is what produces the best trading signals.

So today, I’ll show you a simple way you can do just that.

In the chart below of the iShares Russell 2000 Index Fund (IWM), I combine the two approaches.

(Click here to view larger image.)

At the top is the price action. I highlighted a trading range that defined 2021.

There is a false breakout I ignored, because I learned from older technicians that you shouldn’t include outliers. They skew your analysis and aren’t generally useful.

I included a price target based on that trading range. Here, the idea is simply symmetry. The range was about $19.40 wide. So once IWM broke down, I projected a target $19.40 below the low. IWM bounced off that price level and now appears to be heading higher.

In the middle of the chart is the stochastic indicator. That’s a popular momentum tool that is widely followed by new traders.

In markets where new traders are rushing in, such as ours, the stochastic becomes important to watch. As IWM reached its price target, stochastics gave a buy signal.

At the bottom is the rate of change of indicator. It’s a 20-week ROC with Bollinger bands added to the indicator.

Breaks of the bands are relatively rare. When a break does occur, the signal comes when the ROC moves back between the bands.

In this chart, ROC broke below the lower band and then crossed back above it as IWM bottomed last month.

I use ROC because it shows mean reversions. It always snaps back after going too far in one direction. The snapbacks offer trading signals.

This is a simple analysis, but the point is I’m using a variety of indicators. The price target is based on the chart pattern. Stochastics is designed for trend following and I applied ROC as a mean reversion tool.

You should apply a similar approach when you trade. Don’t get married to one indicator or another. Use all the tools at your disposal until you find what works, and combine them to confirm your trade ideas.

This diverse group of tools all tell us that IWM is likely to move higher from here.

This is bullish for the broad market and tells me that the correction has almost certainly ended.

Regards,

Amber Hestla
Senior Analyst, True Options Masters

Chart of the Day:
Will This Gold Breakout Stick?

(Click here to view larger image.)

Will gold bugs finally get their day?

I’ve been yelling about the gold and silver charts for… about as long as I’ve been writing these Charts of the Day.

I believe that rumors of their deaths have been greatly exaggerated. And this chart might just be the turning point I’ve been waiting for.

After a serious coiling period, where the 9- and 20-day EMAs got real familiar with the 50- and 200-day MAs, gold has broken out of the descending resistance line and is coming back to test it this week.

If we don’t get faked out again, this could be the start of a significant rally in precious metals prices.

Though, there is one caveat.

The action that spurred bitcoin higher yesterday — PM Trudeau imposing emergency financial powers — seemed to do nothing for the price of gold. In the times before bitcoin, this is the kind of thing that would cause a flight to the yellow metal.

So while the technicals for gold look good, the narrative picture is still in question.

Translation? Tread carefully. Gold should never be a huge part of one’s portfolio, and it’s often better to trade than to own… until things really hit the fan, that is.

Regards,

Mike Merson
Managing Editor, True Options Masters