MARKET TIMING

Avoiding False Signals

by Joe Luisi

Some people may think that technical analysis doesn't work anymore, but here's one author's solutions to today's challenging modern markets.

"Every new technician reads the basics of chart patterns and indicators and applies them to his or her trading, only to find they don't work. So how can traders overcome this new wave?"

FIGURE 1: DEUTSCHEMARK, IMM AND STOCHASTICS.
Here's a clear depiction of the false-signal process.
The mark flashes a buy signal when the stochastic indicator moves above 20. The next day,
nearly the entire advance is erased as buyers run for cover and turn into sellers.
"On the surface, these problems appear to make perfect sense; after all, the more people following the same indicators and patterns, the greater the possibility for aberration. If everyone is following the stochastic indicator and it falls below 30, a classic buy signal is triggered. At that point, thousands of screen-based technical traders who follow this indicator will call their brokers to buy at the market. This rush to the phones causes a brief runup in prices, and so it appears that the signal is working out."
Excerpted from an article originally published in the September 1996 issue of Technical Analysis of STOCKS & COMMODITIES magazine. 
© Copyright 1996, Technical Analysis, Inc. All rights reserved.
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