21 Jul Testing the Best Indicator for Trend Following
Testing the Best Indicator for Trend Following
July 21, 2021
We live in an era of headline reading.
Not article reading.
And on one hand, that’s a good thing.
Just getting the gist from a headline is a fast, effective way to get the information while keeping our minds free to work on important things.
On the other hand, a un-generous person or company could manipulate this shortcut and trick us into digesting false information.
We either have to trust the source of information enough to trust the headline, or we have to read the whole article.
[Tip: reading the whole article is always better.]
If we want to be trend followers– and shouldn’t everyone be trend followers??– it would be nice to know what indicator is best for this type of trading.
In short, what indicator gives us the best chance to catch a big trend when it flashes a buy signal?
It would be nice to just have a quick, headline answer.
But, of course, there are all sorts of problems with quickly answering a question like this.
- What exactly constitutes a buy or sell signal?
- Are we using continuation signals or pull-back signals?
- What’s the profit target?
- Are we using a stop?
- Are we using a break-even?
- What timeframe are we using?
- What instrument are we using?
- How much data are we using?
- What settings are we using?
See the problem? A quick headline doesn’t address these issues.
For this week’s research, though, we’re going to try to keep it simple while giving a reasonably good answer.
We’re going to use a hard-trending instrument. Why study trend following with something that doesn’t trend?
We’re going to use a longer-term timeframe, a 4-hour chart.
We’re going to use continuation/breakout signals for a pure look at the beginning of a trend. A pull-back means the mood has changed. We want to examine when the explosion begins and how far it runs.
And we’re going to use default settings.
Which is kind of dumb, actually. Who made these default settings? Why did they make them? Why do we blindly follow something someone said in the past without knowing the logic behind it?
Nonetheless, we’ll stick with default settings (at least at first).
By doing this, it’s reasonable to assume that the indicator that creates the biggest explosion after a signal is a good one to use for trend following.
Of course, there are caveats to that, too. Won’t optimizing change the answer? What if a different timeframe makes a different indicator the best one? And so on.
But if you don’t want the detailed numbers or care about the reasoning behind it, here’s the quick headline:
For trend following, the indicator that produces the most profit is Bollinger Bands™.
But there’s a lot more to it than that.
And we’ll investigate further in our next Newsletters.
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