IDT - Index Day Trading
How to use additional indicator
Let's
assume that you have 5 independent trading indicators that, every day,
show you possible future trends for the market. To each indicator you
assign a level of importance related to how that particular indicator
influences your final decision. Some traders place the majority of
their confidence in one indicator and only use other indicators to
confirm what they know from their primary indicator. It is YOU who
has to decide how to weight these indicators, and which indicators
you are going to consider at all. For example, you could have a
weighting similar to this:
1st indicator: 0.55 (55%) - Volume
Indicator
2nd indicator: 0.15 (15%) - Market Newsletters
3rd indicator: 0.15 (15%) - Other Traders
4th indicator: 0.1 (10%) - News / Talking Heads
5th indicator: 0.05 (5%) - Broker
Of course, all of these up to 100 percent.
Now, let us assume that a situation
arises on the market for which the first, and highest weighted,
indicator shows that the market is likely to move higher. Is this
indicator enough to base trading decision upon? Could it be incorrect?
The best way to evaluate that indicator is to compare and contrast it
with the others in your weighted list. Simply assign a coefficient to
each indicator (on a scale of -10 to +10) based on what they predict
for the future movements of the market. For example:
1st indicator: +7
2nd indicator: -2
3rd indicator: -3
4th indicator: 0
5th indicator: -4
"How do I know what coefficient, or level of
confidence to assign an indicator?"
Assigning
coefficients to your indicators in an entirely subjective task, which,
unfortunately, requires some experience before you master the system.
Don't expect to know what level of confidence to assign your first
indicator on your first day of using this system. What you assign as a
+5 today may be +3 to you after several months of experience.
Don't be afraid to test the system. It cannot
work for you until you get a good track record.
After assigning coefficients to your
indicators, simply multiply each indicator's coefficient by its
weighting and add them together:
(0.55 x 7) + (0.15 x -2) + (0.15 x
-3) + (0.1 x 0) + (0.05 x -4) = 2.9
The result is a signal strength of +2.9. Now, unless
you have a high risk tolerance, it probably is not a good idea to base
a trading decision on an indicator that is in the range of -4 to +4,
as this is what we'd call the "uncertainty" range.
But perhaps the next day you assign the following
coefficients to your list of indicators:
1st indicator: +5
2nd indicator: +6
3rd indicator: +2
4th indicator: +4
5th indicator: +7
Now the summary signal will become:
(0.55 x 5) + (0.15 x 6) + (0.15 x 2)
+ (0.1 x 4) + (0.05 x 7) = 4.7
In this situation, you are probably more
willing to open a long trade. With a confidence rating of only 4.7
(0.7 above the threshold), perhaps you may want to think about only
opening a small long position until the confidence grows.
From the above examples, you can see how additional indicators
can reduce your trading risk.
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