Saturday, April 13, 2013


Studies and Why I Generally Don't Use Them

You probably have noticed that I don't show a lot of studies on my charts. You know, the type that scroll along the bottom of the chart and provide all sorts of buy and sell signals (MACD, RSI, etc.). There are several reasons for his.

First, I have never found the perfect study. Every study has major limitations. What works in one situation won't work in another. If you rely upon studies, eventually they will bite you, and the more you rely upon them, the more they will bite. Their real value is to serve as a way to give up your decision making power, even if nobody else is involved in your trading. You are giving it up to whoever created the study and/or to the common wisdom that "this is a good study." This makes it easier to rationalize your losses ("Well, the MACD and RSI and Bollinger Bands all said to sell!) or to give you extra confidence to go through with a trade. I'm (usually) not looking for that.

Second, just give me price history and volume, and I'll go from there. That's all you really need. Everything else is built on those two facts anyway. Relying on the basic inputs also forces you to hone your pattern recognition skills. Studies aren't magical, they also usually use just past price and volume. Those that pull additional facts out of thin air are suspicious for that reason alone.

Third, fancy studies are distracting and take time away from looking at the chart itself. Stocks move in patterns that ebb and flow with the interest of buyers and sellers (and there are never "more buyers than sellers" or vice versa, there are always the same number of both in a liquid equity, it's a balance of motivation). Fancy studies may or may not catch how motivated buyers and sellers are, but looking only at volume and price certainly will tell you what is going on if you pay attention.

Fourth, different studies rarely are in total agreement. Then, you have to start picking and choosing, and your decision making gets even further removed from the fundamental factors of price and volume.

Fifth, studies have to be calibrated and fine-tuned for different instruments and time periods and situations. They are not, despite what you might think, "one size fits all." I don't have the patience for that, and besides, who's to say I would calibrate them correctly for different situations. Then, you are looking at a study that is removed from the fundamentals of price and volume, and the study is manipulating them improperly to boot. It's not worth it.

There are other reasons for not relying on studies, but I'll leave it at that. My point is, I don't rely on whether the MACD is peaking or the RSI is deteriorating or the price bar moved outside the bands. MACD can peak and peak and keep on peaking until you go broke, while using a 14-period setting may give you a different result than a 21-period setting, and so on.

I'm not a total study snob. If you become a true expert with a particular study and learn all of its ins and outs, it can become your trading right hand. Some basic studies are always useful, such as moving averages (upon which most other studies are built anyway). They organize price and volume in simple ways that have so many people looking at them that they develop predictive power for that reason alone. The more data manipulation is involved, however, the less I want to use a study.

A simple study used sparingly, as an adjunct to pattern recognition and to organize at a glance what I learned from simple price and volume, is pretty much my limit. I'd rather rely on chart patterns that recur and have high probability outcomes than use somebody else's tool whose limitations are not always apparent.

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