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TECHNICAL INDICATORS


The Right Indicator To Succeed

11/03/11 03:09:23 PM
by Alan R. Northam

The result of this analysis shows that the trader must select the right indicator in order to be successful in trading.

Security:   BAC
Position:   N/A

A few days ago, I wrote an article entitled "Which Indicator?" In that article I showed that using a popular indicator such as the relative strength index (RSI) may provide good buy and sell signals for some stocks but not for others. In particular, this article showed that using the RSI to determine buy and sell signals worked well for Intel but did not work for Bank of America (BAC).

However, all is not lost. Just as the RSI works very well for Intel, it is possible to discover another indicator that works equally well for BAC.

To find the right indicator to use for BAC in determining buy and sell signals, a test will be performed using six indicators. These six indicators include moving average crossovers, directional movement, stochastics, commodity channel index (CCI), RSI, and moving average convergence/divergence (MACD). Other indicators could also be added to the list, but this will suffice for our purposes.

Instead of using their respective default lookback periods, each indicator will be optimized for best performance for BAC. To allow us to compare the results of this test to those run for the RSI in my previous article, the test will also be run over the same past five-year test period. Further, both long and short trades will also be included in the test as they were in my last article. The result of this test will show the total profit of BAC for each indicator, the number of profitable trades versus the number of unprofitable trades and the ratio of the average profitable to average unprofitable trade determining the reward-risk ratio. To perform this test, the MetaStock Enhanced System Tester will once again be used.

Figure 1 shows the results of the scan. Each bar from left to right in the bar chart represents one of the six indicators used. The most profitable indicator was the moving average crossover system with the worst performance coming from the MACD.

FIGURE 1: ENHANCED SYSTEM TESTER WITHIN METASTOCK. Results show moving average crossovers as being the most profitable trading system to use with BAC.
Graphic provided by: MetaStock.
 
Figure 2 shows the best five moving average crossover trading systems returned by the Enhanced System Tester. The difference in these five trading systems is their individual optimizations.

While all five best systems show similar results, the best trading system is system 2. System 2 uses a 60-period moving average and a 110-period moving average. A buy signal is generated when the 60-period moving average crosses above the 110-period moving average and a sell signal is generated when the 60-period moving average crosses below the 110-period moving average. Note that the system generated a total gain of 26.18%, had four winning trades and three losing trades, and had an average profit to average loss ratio of 6.13 to 1. With four winning trades to three losing trades and an average profit to loss ratio of 6.13 to 1, a profit factor of 8.17 is calculated (4/3 times 6.13), indicating that for every dollar lost in trading this system, a profit of $8.17 was generated.

FIGURE 2: ENHANCED SYSTEM TESTER WITHIN METASTOCK. Results show moving average crossover system 2 as being the most profitable system to use with BAC.
Graphic provided by: MetaStock.
 
While there are many popular indicators a trader can use in determining buy and sell signals, the trader cannot simply pick his or her favorite and expect to earn a profit from any single security. To earn a profit from a particular security such as BAC or even Intel, a test of all indicators must be performed to determine the proper indicator and lookback period.

Without first running this test, the trader could be setting him- or herself up for failure and eventual loss of all trading capital.



Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.

Garland, Tx
Website: www.tradersclassroom.com
E-mail address: inquiry@tradersclassroom.com

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