SCOTT WELSH TRADING BLOG

Do Indicator Systems Work In Chaos?

Do Indicator Systems Work In Chaos?

Apr. 15, 2020

Do systems based on indicators work in chaos?

Do indicator systems even work at all?

We’ve looked into that topic previously, but I just read another book that says indicators are worthless.

So I thought we might look into it again.

What are the problems with indicator systems?

The indicators themselves are the biggest problem. Traders will scold us for even considering the use of such ridiculous tools because they are “lagging”.

I still don’t know what that means. Isn’t everything lagging? What tool out there gives me tomorrow’s reading?

The real problem with indicators is in the transfer from testing to live trading.

For one, every platform is different. The RSI on one platform will never match the RSI on another platform. Furthermore, the RSI on Testing Mode will never match the same indicator in Live Mode.

In short, testing will never match real life, not exactly anyway. A breakout system, by contrast, will always be the same in Demo mode and Live Mode. The price is the price is the price. An indicator can round something off differently and give slightly different readings. That’s just a part of using indicators.

The other problem with indicators is that circumstances have to set up perfectly to get a trade. A breakout just goes when price goes.

An indicator system may or may not trade when price goes. It depends on the reading of the indicator itself.

Last, a big problem with indicators is over-optimization. It’s very easy to get rambunctious and over-test an indicator. One or two different settings can make huge differences. It’s easy to want to keep optimizing.

A little optimization is fine. A lot of optimization–optimizing every parameter of an indicator, for example–can lead to poor performance in the real world.

But there are benefits to indicator trading.

The first is the discipline that indicators bring. There’s no discussion when it comes to an indicator. If the indicator says “yes”, we trade. If not, no trade.

Plus, indicators weren’t built on a lark. Smart people used smart math to build indicators that give us an edge. Why dismiss that edge?

And psychologically, it’s nice to take a trade on an indicator signal.

Breakouts can be scary. It’s hard to trade when price is making new highs or new lows.

Indicators wait for everything to come together. They look neater. And that helps a trader have confidence.

But the only question that matters, however, is if they work. Do indicator systems make money?

On short timeframes (like 15M), indicator systems definitely test out great. The problem on lower timeframes (as I’ve frustratingly learned) is that bad execution can taint the testing. The indicator says “yes” for a win on paper; the wide spread says “no” for a loss in real life.

On big timeframes, though, this is not a problem. The indicator moves slower and more steadfastly on a Daily chart, and spreads don’t make a difference (or a very little one).

So, we’re going to look at an indicator system with very little optimization on a Daily timeframe.

Here are the details:

  1. Go with the trend. Only take Long trades when the trend is up and Short trades when the trend is down.
  2. Use the CCI indicator to take the entry on a pull-back (set to default 14 length and default Overbought & Oversold).
  3. Use a sizable Profit Target (over 100 points) so we don’t get cheated by spread-widening.
  4. Use a sizable Stoploss (over 100 points) to give the trade room. As we’re told, Oversold can stay Oversold for a while. We need to give it room to be Oversold for a while before heading in our direction.
  5. Once we get a signal, we get in at the Open of the next bar.
  6. We’re also going to use a special time limit. We want to get the full profit target so we will only accept a win or a stopout for a certain amount of days after a trade opens. After that time window, the trade can exit on an indicator reading.

We’ll stick to the most popular pairs for this analysis, and we will keep the settings the same for every instrument.

I’m using a version of the Heron robot for this research (for those familiar with my robots).

How did it do?

Here are the results for the GBPUSD currency pair from 2003-2020 using 1 lot each time with no compounding:

Also see it here.

Not bad. With no optimizing, it performed similarly to a breakout strategy on the same pair. Profit was about 3x max drawdown and the win percentage was reasonably high.

Has it worked in 2020’s volatility? Not really. It’s only taken 2 trade for a overall loss of about $300.

It’s been hard for some systems to get setups this year.

But we’re not done with this topic.

A little money management makes this system very, very interesting.

And we’ll talk about those changes in our upcoming newsletters.

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Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.