It is important to understand that human behavior drives the markets… and any indicators that you use should be used in this light. When some news or report hits the market, it is peoples perception of the significance of the move and their reactions that effectb prices.
So if a report is bullish… a bullish consensus develops where there is more buying, which drives prices up. Same way with technicals. If prices break a trendline, a large amount of traders may percive this as a change in trend, so a shift in consensus takes place.
A directional bias developes and again there is more buying than selling, which drives prices up. If prices continue to rally, perhaps trend followers will get fresh signals from moving averages, and more money flows in the direction of the new bias. And so it goes…
What indicators to use is a personal choice. Personally, I have settled on several indicators and analytical methods to help me guage the markets sentiment. I will list these now, not to tell anyone what works best, but rather, to list a few subject areas that new traders may further investigate. These indicators and methods work for me.
(1) Identifying a trend. There are many methods of identifying a trend. Simple trendlines can be used, as well as charting swing highs and lows, and using moving averages. In most cases, all I use is my bright, trained eye.
Why try and identify and trade in the direction of a trend? Because it only makes sense to take the path of least resistance if this path can be identyfied. A trend denotes a directional bias. It signals a dominant consunsus shared by the market participants.
It must be understood that large amounts of money enter the markets due to large scale traders. This flow of money by traders, financial institutions and commercial interests is usually in the direction of a trend. Which creates increasing momentum in the established direction. Small traders can attempt ti *piggy back* on the big money.
I find no need to monitor and track COT reports, when athe simple bar chart reveals the directional bias (or lack of one) and dominant consensus of the market participants. This is why the *trend is our friend*.
In discussing trends, I constantly apply an attitude that I call *multiple trend analysis* – where trends are identified accross multiple time frames. This allows a *birds eye view* for better trade decisions, risk assessment and profit potential. Ideally I want to trade in the direction of the trend that is dominating the time frame greater that the one I am trading. So if I am trading off the daily chart, it behooves me to be aware of the weekly trend. A daytrader trading the 5 minute chart should be aware of the 30- and 60 minute chart.
Doing a multiple trend analysis allows one to identify changes in the long term trend early on… lending greater confidence in trading a smaller time frame, and increasing the probabilities of success.
(2) Cycles and natural retracements. I believe that the markets are but a graphical representation of the thoughts and beliefs of its participants. As previously mentioned, it is people that move markets. Human behavior, which is a natural phenomena, conforms to many of the natural laws of nature. One of these is the existence of cycles.
I cant get into details in this text, but I will say that just as cycles appear in nature,they also are evident in human behavior, and thus, price action.
The forces of expansion and contraction are always at work in the markets. Extremes of emotions and sentiment in the markets are the norm… which is usually followed by a shift in another extreme direction. I call this *reactive emotional consiousness* which is almost always at work across all time frames. Periods of optimism are followed by periods of uncertainty. And so forth. This is graphically displayed on price charts, where you can see a strong move in a given direction… followed by a stall and reversal.
Natural retracement is a concept most everyone knows. The markets will often reverse at a natural retracement of its prior move. The concept not only applies to price movements, but also to TIME.
Markets will often retrace and reverse direction at a time retracement. The use of retracements for projecting turning points, along with using price retracements and a cycle indicator can be a very effective combination. Being able to anticipate a turning point will allow for preparation and greater confidence in taking a trade, once a signal is generated.
One final note about cycles. Not only are cycles present in price and time, but cycles are also evident in momentum and volatility. Momentum and volatility expand and contract… and so does trend.
For continuation, see part five of this rather long original article.