Wednesday, January 31, 2018

Unmasking the VooDoo - Michael's Rules

This post is a little different than the others where I usually take a deep dive into one bit of technical analysis or another to expose what's really going on beneath the hood. In this post, I'll simply list my rules for dealing with the analysis in the real world and not in some idealized trading lab.

Sorry AI. This is your daddy, RI (real intelligence). This is what you are trying to be when you grow up.

Follow these rules. You may not make big bucks trading but you will up your win rate. Plus you will definitely avoid misinterpreting the market's message and taking bonehead trades.

I've got some comments below the list, as well.

Michael’s Rules

  1. If you cannot see trends and patterns almost instantly when you look at a chart then they are not there. The longer you stare, the more your brain will try to apply order where there is none
  2. If you cannot figure out if something is bullish or bearish after three indicators then move on. The more studies you apply to any chart the more likely one of them will say “something.” That something is probably not correct.
  3. You can torture a chart to say anything you want. Don’t do it.
  4. Be sure you check out one time frame larger than the one in which you are operating (a weekly chart for a swing trader, a monthly chart for a position trader)
  5. Look at both bars (or candles) and close-only line charts to see if they agree.
  6. Patterns must be in proportion to the trends they are attempting to correct or reverse. I like the trend to be at least three times as long as the pattern.
  7. Patterns should have symmetry. A triangle should look like a triangle and not a mile high and an inch wide (or vice versa). A head and shoulders should look like a central peak with two smaller but equal peaks around it.
  8. Price rules but it is better when volume, momentum and structure (patterns) agree. Sentiment is a luxury.
  9. Always confirm one type of analysis with another type. For example, confirm RSI not with MACD but with on-balance volume or relative performance.
  10. Don’t get hung up if all your indicators do not agree. They never will all agree and you will end up missing every opportunity. Therefore, pretend you are a trial lawyer gathering a preponderance of evidence, not guilt beyond a shadow of a doubt.


on point 5 - In other words, get different charting points of view. They don't have to be in lock step but they cannot tell you radically different things. If they do, find another thing to trade.
on point 6 - This is a pet peeve. You cannot count the trend as part of the pattern. The pattern must be a separate chart entity.  Also, cup-with-handle patterns are continuations, bottoming reversals. Call the latter something else, please!
on point 9 - RSI and MACD are essentially the same thing. Look at something that covers volume. Look at something that has some sort of sentiment component. Look at something with a time component.