Technical Indicators

The Smart Profits Report: Issue #183
Wednesday, February 9, 2005

Technical Indicators: How to Overcome the “Evil Twins of Trading”
By Mt. Vernon Research Team
Mt. Vernon Research

I don’t care how much I know, how long I’ve been doing it, or how well I’ve done it, there’s always something more I can add in options. Some way to improve. Every performance is a potential lesson, and it is the trades that go wrong that have taught me the most.

I’ve mentioned before that I write down why I make every trade. What technical indicators I followed… what news or fundamentals attracted me… what the chart was showing at the time… what I expect the stock to do…where I should get out…

When I looked at my misses a few years ago, I found I did better in trending markets. My trading took a huge leap when I realized that was a weakness in my system and worked on some additional strategies to handle it.

You may not have that problem. But I will bet you have my other weakness… or its evil twin… That would be jumping in too early, or waiting too long to pull the trigger.

If you identify and root out these two timing problems, you can increase your overall returns by 10% this year - and individual returns by as much as 50%. Let me explain…

Get Ready, Get Set, Get Back

Most technical indicators catch trends after they’ve begun. Even simple chart reading. You can’t tell a stock has bottomed, for instance, until it rises off the bottom. So whatever system you use, you don’t get 100% of a stock’s rise as a rule. You get 70%-80% of the move if you act as soon as you get your signal.

Naturally, I figured I could improve on that. Especially when my big idea was based on a stock I liked as an investment that was getting into a strong trend. Or when I saw one of the overpriced trash stocks take a dip. Or when I read a news item that sparked a brilliant insight.

Once upon a time, I was the kind of trader who would read a story on paper shortages and assume Kimberly Clark calls would be a great trade. Paper and Forestry stocks were bound to go up, right? When I got a little more sophisticated, I started timing my trades better with technical indicators.

Tweak Your System With Technical Indicators - But Never Cheat It

Now I had the right tools, but I misused them too often. I still jumped too soon. I didn’t want a trade to “get away.” If I was waiting for a stock to go above $42 to give me a breakout signal, I’d trade it when it got to $41.75. And I’d never wait for a pullback, which would give me a better risk-to-reward potential. It might not pull back. I’d miss it!

If I were waiting for a MACD (Moving Average Convergence Divergence) cross - a classic technical indicator - I’d open up my trade when the lines had almost crossed. I mean, what’s a little daylight between lines? Everything was already headed my way… the train was on the track, why wait?

Why an Early Start Is Twice as Hard

All the standard technical systems are based on lots of data or strict formulas, and most of them work either directly or indirectly with support and resistance levels. It is hard for a stock to move through support or resistance. What happens when you get in just a little too early is that you set up right at the most difficult possible place. The stock that rose to $41.75 wouldn’t go right to $42. It would drop back on me, then try again, then again. By the time it finally crossed the $42 line - if it ever did - I’d wasted a lot of time value on my option.

If you are trading short-term options, you should be doing some chart reading. Technical systems are necessary to help you out. They can range from the very simple (such as looking for a strong trend with good volume) to the complex sets of indicators that I use.

But learning to wait until the prime moment when your system is really where it should be - not headed that way, really there - will probably add 10 percentage points to your average just like that.

And if you aren’t the type who bolts out of the gate too fast, look at your misses - or better yet, the trades you almost made but didn’t - and see if you have the exact opposite fault: “analysis paralysis.” The evil twin of jumping in too soon is waiting too long.

Just One More Little Thing

Oddly enough, it’s possible to suffer both weaknesses.

I know. My old trading books are full of symbols I’ve written down with three check marks beside them. That’s my code for a stock that’s supremely ready to trade. Except that I didn’t. Oh the 100%-ers I’ve missed waiting too long…

Both faults - moving early or waiting too long - trace back to confidence. Trading too soon happens when you’re overconfident. Particularly when you’ve had a string of wins. Waiting too long happens when you are feeling skittish and it’s apt to sneak into your repertoire when you’ve just had a loss.

As I have said before, if you are getting 50/50 results with your options trades, you are doing quite a lot right already. You only need to improve one or two little faults to turn that into a winning record.

Good Trading,

Mt. Vernon Research Team