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A Quick Study of Indicators7/12/2007 6:34:05 PM
Technical analysis is infinitely interesting, particularly when you study the Wave Principle and the indicators that you can use with it. Bob Prechter has been doing that for decades, and he has some solid advice about how to handle the myriad indicators that inundate traders. For one, he says, stick with a few tried-and-true indicators rather than getting bogged down by too many. Read the rest of his interesting interview with a financial journalist in this excerpt from the book that collects dozens of his Q&As with journalists, Prechter's Perspective.
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Excerpted from Prechter's Perspective, revised 2004
Let's look closer at your method, which is first of all a technical approach. How do you sort out all the indicators that are out there? How do you decide which ones you should listen to and which ones you should ignore?
Bob Prechter: I like to use indicators that help me anticipate. I don't like indicators that make me wait until after the turn has occurred, so I've spent all of my time looking at anticipatory indicators. If I get into the common situation where there are two or sometimes three valid interpretations under the Wave Principle, I use the indicators to help me decide which is more likely. But if an indictor fails me in a big way, I throw it away. An indicator that gives a completely false signal should be discarded.
So which ones have you settled on?
Bob Prechter: I don't like stochastics or other price velocity indicators that have ceilings. Unrestricted momentum indicators – percent rates of change, for instance – are better. Take the current day's price and compute its percentage difference from its price X time units ago, and do that over a broad time spectrum. Moving averages give signals far too late, as far as I'm concerned. Your goal as a trader should be to buy weakness and sell strength. While top and bottom pickers who don't have a method get destroyed, trend followers by design buy strength and sell weakness, which is a big strike against their potential profit and loss. What's more, every computer jock on the planet uses stochastics and a moving average system, so you're often buying and selling with the crowd, at least on a short-term basis. You need to use indicators that allow you to buy or sell ahead of the moving average contingent.
What about volume? Does it give you any clues as to where you are in the wave structure?
Bob Prechter: Other than price, volume is one of the most important things to watch. Generally, increasing volume on a fifth wave means that the wave will extend. Light volume in a supposed third wave means it's not a third wave. Both of these situations present invaluable information. Remember, it's happening at all degrees, so there is a lot of information to assess.
How do you weight various indicators?
Bob Prechter: The winningest formula is:
The Wave Principle, applied thoroughly and with discipline to price and volume activity
Percent rate-of-change indicators of varying lengths, from hours to years, to help confirm the wave status of the market and confirm trend change indications by divergence
A few tried-and-true sentiment indicators
Do your indicators as a whole affect the way you view any given indicator? Or does a certain ratio of bulls to bears or a certain divergence from a moving average always mean the same thing?
Bob Prechter: Many indicators have suffered tremendously because people treat them as absolutes instead of relating them to the rest of the market environment. It is never their levels that matter: it is their relationships to recent behavior. A momentum divergence, for instance, i.e., a lower high in a momentum indicator against a higher high in the market, is more important than the level of the oscillators.
What do you think of other methods of analysis that come out from time to time?
Bob Prechter: I look at them all when they come out. Almost every one is some variation, usually very minor, in a momentum indicator. You only need two or three types, and you only need the simplest construction. Advance-decline oscillators and rates of change in the broad market are all I feel I need.
If you want to use an exponential moving average, that's O.K. If you want to have a fancy combination of volume and advance-decline numbers and 60 other things, that's O.K., too. But when you plot them on a chart, they behave in exactly the same way as the simple ones. They give you signals for the same reason – either divergence or extreme readings.
Do hourly, daily and weekly charts work differently in different markets?
Bob Prechter: No. The market is fractal, so they all behave the same way. Of course, one degree of trend can be sideways while the other is trending. One of the most interesting comments in R.N. Elliott's Market Letters is his comment, "In fast markets, the daily range is essential, and the hourly useful…. On the contrary, when the daily range becomes obscure due to slow speed and long duration of waves, condensation into weekly range clarifies." In other words, keep them all and trade with the clear one.
What are the characteristics of a good technician?
Bob Prechter: One of the best that I know is Arthur Merrill. Arthur's most intriguing characteristic is his combination of open-mindedness and close-mindedness. He is open-minded in being willing to explore any idea that could be construed as reasonable, yet close-minded with regard to the fact that he requires statistical proof before relying on anyone's assumptions about the effectiveness of an indicator. Through the years, he validated numerous indicators while rejecting, for instance, the utility for stock market timing of the occurrence of full moons – a darling of the astro-economists – and also the forecasting value of earnings – a darling of fundamentalists. He also wrote a concise exposition of the Wave Principle as an appendix to his Behavior of Prices on Wall Street book.
What did Robert Farrell, who hired you at Merrill Lynch when you were first starting, teach you?
Bob Prechter: Patience, among other things. It wasn't just market-oriented patience, but professional patience in general. Letting things have time to take their course. And, really, this goes back to the philosophy of the Wave Principle itself: You've got to let trends develop to their fullest extent in their own time. What you can do is recognize the pace and adapt to it, and that brings a lot of peace of mind.

Why W.D. Gann Says Stocks Will Top Out in 2007 (Video)

I'm sending you a new video that reveals a forecasting method that may be new to you. And if you're familiar with W.D. Gann, you probably have not seen his methods applied this way.
You can access it immediately here: www.GannGlobal.com/v/sp04?img=157&kbid=1471
This 20 minute video "pulls the curtains" on a revealing historical analysis of the S&P 500 using the methods of W.D. Gann.
Many traders and analysts try follow Gann's techniques. But, most of them lack the most important tools to replicate his most successful methods.
W.D. Gann was a student of history. He consulted history on a regular basis during his trading career.
And the study of history is the main part of his work that is most OVERLOOKED by "Gann Experts." In fact, his most highly valued secret, which he revealed in his $30k trading course was the Master Time Factor. This was Gann's observation of cyclical patterns in the markets, especially, 10, 20, 30, 60, and 90 year cycles (obviously a result of deep historical study).
In this new video you will see the historical record as Gann would have, using technology he did not have. You'll see the comparisons of the bull markets of yesterday, with the bull market of today.
This type of analysis requires a database of daily stock market prices back to 1928. In this video, you'll get to see a glimpse into that database, and an important forecast for the Stock Market that could have a profound bearing on the direction of the Stock Market in 2007.
Here's the video link again: www.GannGlobal.com/v/sp04?img=157&kbid=1471
Trade Smart. Not Often.
Brett Fogle
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