Understanding Indicator Behaviour

Hello all,

Firstly, may I thank all those who wished me well by PM while I was confined to barracks. I have had some health issues but I am still alive, and ready to fight another day! A word of advice to all the young blades on this forum -- If you can possibly help it, don't get old. It's not all fun and free bus rides...


WHAT DO INDICATORS REALLY DO?

A number of folk (who are labouring under the misapprehension that I am a great trader) have asked me quite alot of questions about indicators.

As you may know from my posts, I am not a great fan of indicators. I gave them up many years ago around the same time I gave up smoking. Both are addictive and take a lot of effort and willpower to kick.

However, I am not dismissing indicators altogether. It is just that many folk, especially inexperienced traders, use them willy-nilly with no real understanding of what the indicator is - or more importantly, is not - telling them.

As a consequence, they get very mixed results. Sometimes the indy works great (usually during demo), other times (usually in a live trade) they get stung.

So I am starting this thread in the hope that we may shed some light on the behaviour of our favourite indicators. Knowing when they work, AND when they DON'T work, is vital if you want to minimise bad trades.

Generally, the market is so noisy that it is very difficult to see the underlying behaviour of an indicator on a real price chart.

So I am currently making some synthetic price series with different characteristics to help you see what is going on. You can put your favourite indicators on and see how they really behave.

My hope is that this will give you some real gut-feel and insight into how to best use indicators and get the most from them.

The History (.hst) files attached simply go in your MT4 ../history/xxxx folder where the data files for your broker are stored. Then you can simply open them as "offline" charts and do whatever you want.

I have attached the first two (in the Zip file at the end):

AAAAAAB is just a simple cycle, which is useful for looking at lag issues.

AAAAAAC is a composite waveform that is very revealing in Divergence studies, among other things.

I will add other types of price behaviour as we go along.

I have also attached some charts of the AAAAAAC waveform so you can see the performance of various automated divergence indicators that you can find on this forum.

On one of the charts, I have also shown the popular "Cycle Finder" indicator. This is one of the most beguiling indicators you will see because historically, it looks just about perfect. But it repaints horribly, so beware!!

Always be aware that if an indicator looks too good to be true, it almost certainly is!

I hope that this thread will help folk understand their trading a bit better and contribute to your success. I hope those wishing to learn won't be afraid to ask questions, and I also hope those with more experience will chip in and contribute.

I will try to answer as best I can - "my door is always open". I might not repond immediately as I generally check in around twice a week. "I'm a trader, not a poster", to paraphrase Meatloaf...

Good luck everyone,

Old Dog

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Hello all,

Here's another useful tip.

The chart below shows the AAAAAAB file of the simple cycle. This chart has a period of 100 bars.

The crimson line is the 50SMA and the blue line is the 100SMA.

You can clearly see how lag works in the crimson line. If you use your cursor tool you will see the lag is 25 bars, or HALF the period of the MA.

The 100SMA line is interesting. It is completely flat! This will always happen when you put on an SMA whose period is an exact multiple of the period of the bars. If you are seeing cyclic behaviour in the chart (often seen on the M1 chart) you can estimate the period using this method.

Best regards,

Old Dog

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Hello all,

Here is another price series, a bit more random than the last ones.

[AAAAAAD.hst in the zip file attached]

I have used the trick above to estimate the cyclic components and used these values in two stochastics, see attached chart.

Note how there are times when the two stochastics line up perfectly (I have highlighted these in the magenta boxes) and other times they wander apart.

Clearly, the best "trends" in this chart are during those times when they align. At other times, we might consider the market to be "ranging".

This is a very interesting idea and one I use quite a bit. For much more information see...

http://www.forexfactory.com/showthread.php?t=37111

Kind regards,

Old Dog


EDIT. Just put the .hst files in the folder where all your other .hst files are and re-start the terminal (see picture of my folder).


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Hey Old Dog

I hate to be that guy, but how do I access these .hst files in MT4? They don't show up in the Offline chart list.

I've mostly weaned myself from indicators, as well. (Quitting smoking was much easier in my case.) I rely primarily on stochastics these days because I believe they're real-time, non-lagging, non-repainting and, therefore, somewhat reliable. You've got me wondering if I might (once again) be wrong, so I'm curious to see their behavior using your tests.

Thanks

hi OLD DOG ,
I have been going through your thread its quit enlightening heiken ashi is special and unique would you be kind enough and please share that with me please your help would be greatly appreciated

Hi HumbleLearne,
Could you please explain about HA and why we need it in cycle, sma, etc ? I just know that HA is calculated after bar closed, and it has a different value of OHLC than simple candle stick, but do we really need it for this ? i mean: can we use it to calculate a custom indicator ?
I am really confused ... please give some clue or links where i can find information about it. Thanks

If I remember correctly, Heiken Ashi (HA) is a candle drawn against moving averages 2 and 6. So, if you drew those moving averages on a chart, then each 2/6 crossover should be where the HA candle changes color.

Hi dkrock,
Hm .. so may be my understanding of HA below is not right ...

1. Close = (Open + High + Low + Close) / 4
2. Open = (Open of Previous Bar + Close of Previous Bar) / 2 – This is the midpoint of the previous bar.
3. High = Max of (High, Open, Close) – Take the highest value of the three.
4. Low = Min of (Low, Open, Close) – Take the lowest value of the three.

I just think that it could be useful , but i could be wrong thought ...
Any way, thanks dkrock.

Not all HA are written the same, but the standard meta trader 4 version is the code you posted. Basically, that code would make it a median indicator. It measures for the midpoint and changes color according to whether price is above or below it. As a median indicator it would likely whipsaw quite a bit, which is probably what prompted some coders to alter it. I also remember reading somewhere that the next HA candle as an 84-86% chance of being the same color, but that would really depend on volatility.

Hello OD
Just want to stop by expressing my gratitude for this thread.
I played with files you uploaded and that helped me understand better indicator behaviour.
I hope you are well.
All the best,
Weyk