In this video, we're going to talk about technical analysis indicators and signals. I think it's going to be a good talk today because we're going to get a little bit into the different types of technical analysis indicators that are out there and then also talk about what works and what doesn't.
First of all, we want just to define what technical analysis is for those of you who don't know or are new, but it's just a methodology for forecasting the direction of prices through the study of past market data, primarily price and volume.
Over time it's been increasingly popular, because of it's easy and visual nature of the indicators, meaning you can see the indicators on the screen. There's nothing abstract about it. There's nothing out there.
You can visually see if something is a buy or a sell, but that also falsely leads to the assumption that the markets are predictable.
I think this is one of the biggest points that I want to make in this video is that the visual nature and the easy to read nature of technical analysis does not mean that it is predictable in determining the outcome of the direction of stock.
I know that a lot of people fall into this pitfall earlier on in their trading career, is that they see the technical analysis indicators and it makes sense to them, a logical basis, so then they assume that because it makes sense and because they can see it, that it, therefore, is predictable, or you can basically make assumptions off of it, or trading them profitably off of some of these indicators.
I'm here to tell you that that's just not the case. There's a couple of different types of technical analysis indicators out there or methodologies. There's first your general support and resistance. The stock goes up; it hits an area of resistance, comes back down, hits an area of support et cetera, et cetera, et cetera.
Then you've also got Candlestick patterns. These are patterns relating to the open and close of the price movement in the day, about the high and low. Again, it's not the actual Candlesticks themselves, but it's the patterns that evolve through these Candlesticks.
A three day or a four-day pattern might tell you something about what the stock might do in the future. Then we have Chart patterns, which are popular. Things like Head and Shoulder patterns, pennants, flags, all these different things, cups, and handles.
You probably heard them if you've been involved in trading. All of these different patterns that are out there, that you can build and write and draw on it with all of your charts.
Now, in my honest opinion, a lot of these are subjective in nature. What might look like a Head and Shoulders top to you, might also look like an up trending pennant to another person? You can't argue with that.
With regard to Candlesticks, Chart patterns, support, and resistance, it is all subjective, meaning it's what you see out of the charts, not necessarily what may or may not be there.
Since I'm more of a math and numbers trader, based on probabilities and statistics, I prefer to use indicators that give clear buy and sell signals on the charts. That's just how I'm wired.
Obviously I want to go through some of these examples here, so we can start to lay the foundation in this video, for how we can use signals that are less subjective then say chart patterns or Candlesticks, things like that.
First thing that we're going to do is we're going to look at a chart of SPY. Now, this is the SPY at the time that we're doing this video. This is the last two years on a daily basis. What I've done here, is I've overlaid just the simple 15-day moving average. This is that green line that you see here.
Moving averages is one of the more popular indicators that you get started with, especially if you're new in trading. The whole methodology here is that, whenever the stock crosses above the moving average, then you want to buy it.
Whenever the stock crosses below the moving average, you want to sell out of your long position or go short, whatever the case is. Obviously, every indicator is going to work in some scenario, and other times it's not going to work.
This is again a very simple explanation or example of how an indicator give clear buy and sell signals. Again this is some of the stuff that I prefer is to use indicators, not necessarily simple moving average, just to be clear, that give indicators that are clear buy and sell signals.
Note that the stock crosses below it, so that's my buy signal or my sell signal, whatever the case is. There's also a bunch of other different types of indicators that you can add out there.
For example, you can add another popular one is stochastics. We can add let's say full stochastics to our chart here. With full stochastics, what you're looking for ... In this case, you don't see any moving average up there, but what you're looking for in stochastics are these overbought and oversold zones.
Basically you hear the terms, or probably will hear the terms if you trade long enough, a stock is relatively oversold or relative overbought. Basically whenever the stock gets up into one of these zones, where it's overbought here, or if it's oversold here, that those end up being the buy and sell points on the charts.
Again it just correlates and gives very clear signals, based on whatever you've set up as to where you should buy or sell. There's a bunch of different variations in here too. I just want to go through some of these, so you guys can see.
We've also got things like Bollinger Bands. These are becoming more popular. Again very clear buy and sell signals with Bollinger Bands.
You're looking at buying and selling the breakout of every single move, so when the stock breaks out of the lower boundary and then if the stock ever breaks out of a higher boundary then ...
It didn't here, but if did, if the stock ran up and broke out of this higher boundary, that would be your sell signal. There are all types of different indicators out there. Again most of this technical universe here is based on price movement, volume, acceleration, things like that.
Some other ones that are out there are MFI, which is Money Flow. This is another one that's very popular or becoming more popular. You can see Money Flow has even clearer signals in some of the things like Bollinger Bands or stochastics. It's just one line and it then again shows you an oversold range.
Whenever the stock indicator, MFI gets here, then you want to sell stock. You would sell stock or go short here, or sell stock or go short here and you might buy at these lower regions, which is buying here, et cetera, et cetera, et cetera.
There's a bunch of different ways that you can do it. There's thousands of different technical indicators out there that you can use. I think the key is that, if you're going to focus on anything, just first focus on the indicators that give clear, like mathematical reasons why there is buy and sell.
I don't prefer to use anything that's subjective in nature, meaning that it's a trend line that I'm drawing on the chart. How do you know that this ...
This is a great example of this, but how do you know that this is supposed to be the support and resistance line? Versus is this the support and resistance line? Is this support and resistance line? Is this the support and resistance line?
All of that thing could be valid support and resistance lines, but they're all subjective to me. They don't give us any clear indication of why something might move higher or move lower, creating a buy or sell signal.
Here's the deal, the real question becomes, which indicators work? Which ones are reliable enough long term in the trade? The question you might have is, should I be trading using SMAs?
Which is Simple Moving Averages or stochastics, or MACD or RSI or ... All the other different indicators that are out there. Which ones generate a profitable trade that out performs the market.
Even if you did find XYZ indicator that works, meaning that it is reliable to trade. It has good signals that work more often than it doesn't, does it generate profits? When it works, do the profits overshadow the potential losses when it doesn't work?
I think that's a real key question, which not enough people ask in this industry. Here's the deal. Back in 2014, we purchased our own in-house data and developed an in-house program to back test technical analysis indicators.
Once we had everything in place, we started back testing hundreds of stock and indicator variations, covering the last 20 years of market data. After 12 months of nonstop back testing and analysis, we packaged everything up that we discovered and put it into a single comprehensive report.
Here's the deal. We are selling this report called Signal on our website. It is one of the ways that we generate money here at Option Alpha, even though we give away 99% of the things that we do.
This is something that I think is game-changing and I think it's something that everyone should have, but not everyone needs to have, or we don't want to give it away for free because it's so freaking good.
We did 20 years of data, 223 different stocks, 17 different technical indicators. We're talking about things like MACD, Stochastics, Bollinger Bands, Money Flow Index, volume oscillators, everything in there.
17 different indicators, 1,476 different variations. What I mean by this has we tested the granular difference between buying at a six-day moving average, versus buying at a seven-day moving average and an eight-day moving average.
What's better? Do I use a six, a seven or an eight-day moving average? 1,400 different variations between all of these different indicators. The groundwork has been laid.
We tested the living daylights out of the technical analysis, to see what works. At the end of it, we ended up tracking about 17.34 million trades over the course of our year plus study, with all these different indicators and stocks.
Basically we're looking for three questions to be answered. Number one, is technical analysis more reliable than randomly picking a stock's direction? Honestly, nobody's asked this question in this entire world.
If all this stuff is so good, how good is it? Is it more reliable than randomly picking a stock's direction? That's number one. Number two, if its, can you generate an excess return above just holding the market?
Now the question always becomes, is the market more efficient than any of these technical analysis indicators? We wanted to figure it out. One, if it was more reliable than randomly picking a direction, can you make generate money above the SMP 500?
If you can, what are the specific indicators and settings that work best long term? Again, it was the difference between finding out, does the six-day moving average as an indicator work better than the 10 or the 50 or the 100?
Does the 21 RSI work better than the 18 or the 15 or the 13 days RSI? What are the settings that worked best long term? Now, of course, I'm not going to show you all the results in this video today because you do have to purchase a copy of the report to see what works.
There are four things I wanted to quickly reveal to you, that we learned from the report which will help you with technical analysis, regardless if you purchase or not. That's what I wanted to get across here in today's this video because I think just knowing these four key aspects, will dramatically help your success rate.
Again whether you choose to buy a report or not ... You do not have to. We're not forcing you to buy it. It's not required to be successful trading options. It's for the people who want to know what indicators work and what don't.
If you know these four things, I think it will help you get a better understanding of the relationship between profitability maybe and technical analysis.
The four key numbers that we're going to go over here are the following. One is that, exactly 39 or about 5% of the 766 different long indicator variations that we backtested, beat the SMP 500 benchmark net return.
This means that 95% of the technical analysis indicators that we tested, underperformed the market. This is incredibly important because what this means is that, 95% of the indicators that are out there are junk and garbage and don't work.
Your goal is obviously to back test by yourself. Buy the report from us if you want to do that, but find the ones that do work. If you can't find them, you might even be better off just not using any technical analysis at all. That's just the reality.
The average win rate of all technical indicators tested long and short was just above 45%. What this means is that as a group, flipping a coin would have been more consistent with a strategy of buying and sell signals.
This gets back down to what I was talking about before. You do not have to purchase this report. Just with these two numbers, you realize that you have a higher probability of success overall ...
We're not talking specific ending here; we're talking overall. You've got a higher probability of success if you flip a stinking coin and buy or sell the stock based on heads or tails of that coin flip.
As a group, everything that we tested, so many different indicators, so many different variations. As a group, they were very inconsistent with just being able to pick a direction.
Now obviously, some indicators were better. Some indicators were worse. As a group, they were so so, to less that profitable with a coin flip.
208 test variations blew up the model portfolio entirely. This is about 27% of the variations that we tested. That means that they created losses of more than 100% after commissions and notably short term, or day trading timelines under 30 days were not profitable.
This one to me is the big one because we can basically put a fork in the ability for somebody to consistently, on a long term basis ... We're talking 20-year basis here, profitably predict where the market is going to go on a day trading timeline.
Now you can go ... Again you don't have to buy this report now. Now you can go out, figure out if it works for you or not. Try day trading. Come back after a year, after you've lost money. Tell us that we were right, that it doesn't work.
If you've already day traded, you know it doesn't work, but now we've proved with numbers and statistics that it doesn't work under a 30-day timeline. Even really ... Okay, just a little hint here. Even 30 days plus, really doesn't work. We'll get into that a little bit deeper in the report.
The reality is, is that some of these indicators are so bad, that almost a third of them blew up the portfolio. That's cause for concern. Again you don't have to buy the report to know this.
Now you know, you should probably stay away from some of the indicators that might blow up your report, or blow up your account.
The last thing is that transaction cost as an overall percentage of gains, losses, accounted for approximately 7%. Generally speaking, transaction costs were not a major drag on overall profitability.
What this means for me, is that there is no link directly between people who trade more and necessarily are going to lose, because they trade too much. There was no direct link that we found, between overtrading and profitability.
If you traded a lot, you could still make a lot of money. If you traded a little, you could still make a lot of money. This idea that sometimes you can overtrade and trade too much, I think is not true.
I think you can reduce risk by trading smaller, more frequent sizes. Again, we tested everything in our report from a 1% allocation per trade to a 2%, a 5%, a 25% allocation per trade. We tested everything to see what worked as far as allocation as well.
Again what we found is that the transaction cost and the churning of the account really didn't have a drag on profitability. What mattered more so in transaction cost, broker fees, all that stuff, actually were you using the right indicators or not? That's what was key.
Here's the point. The right technical analysis indicators can help you make more profitable trades. The top five indicators we found generated winning trades 82% of the time and outperformed the market by 2,602% on average.
Again that's after combing through 17.34 million trades to see what works. When it comes to options trading, selling options based on high probability strategies with defined risk, always outperformed even the best technical analysis indicators.
Once again, if I haven't said it a million freaking times in this video. If you want to buy a copy of Signals, we would be more than glad to sell it to you. I think it's an incredible piece of research and we've gotten a ton of amazing feedback from it.
If you are going to be successful in this business, you don't need technical analysis to be successful. It can help, but it is not required. Again, technical analysis can be a supporting factor in your decision to long or short stock directionally, bu it should never be the only factor.
Hopefully you guys enjoyed this video. It probably was a little different than you might have expected to head into it, and that's okay. I want to know what your comments and your feedback are.
If you have questions about different indicators or about anything that we covered in the report, please let me know. If you love this video, please share it online. Help spread the word about what we're trying to do here at Option Alpha.