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Confirmation
Every day there are a number of different signals generated from different methods
for predicting the future direction of the market. Some signals are generated very
frequently but are well below our target of 60% winners. We can use these signals to
weed out some of our bad trades. The confirmation signals need to be present often
enough and of sufficient quality to avoid vetoing too many good trades.
The key to making good trading decisions is to pick good primary signals and good confirming signals.
Charles Dow was an important trader that founded the Dow Jones Industrial Average. He used the rail
stocks (Transports) to confirm moves in the industrial stocks. The idea being that the industrials had
their product moved by the rails in most cases. Strong rail volumes confirmed that the industrials
were producing more.
Confirmation improves your overall performance by increasing the percentage of winners. It reduces the number of winning trades and losing trades, but the
reduction in losing trades should be greater in its effect than the reduction in winning trades. If you had 120 winning trades and 90 losing trades, then you
have 57% winners. By using confirmation you will probably remove 19 winners and 31 losers. The new numbers are 101 winners and 59 losers: 63.3% winners.
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The improvement that confirmation provides is a key step in achieving the highest levels of trading performance.
A classic way to confirm a trade is volume. If a breakout occurs on above average volume then the move can be considered confirmed. Confirmation needs to be
thoughtfully applied because there are no "Laws of Confirmation" that always work. On a gradual advance higher, there probably won't be volume confirmation.
From the chart
on the right you can see that volume does work sometimes, but not always. Sometimes volume indicates a blow-off top.
It will take some practice to make volume work for you.
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Using candlestick chart interpretation theory you can find confirmation. Patterns like the Hammer, Hanging Man, and
Shooting Star can provide effective trade confirmation.
Using a Tell is a good way to achieve confirmation.
This video was made by MarketPirates.net to explain Tells.
Indicator signals are a very common way to find confirmation. Some indicators are based on the price action and primarily serve a delaying effect to get you
to wait a little longer. A classic example of the delaying effect is to use two moving averages: when they cross over to the up side then go long and when they
crossover to the downside then exit (or go short). MACD is often used for similar reasons.
To move beyond a simple delay, you sometimes need to bring in another source of information. TICK and ARMS indicators attempt to do this but I have had little luck
with those indicators. I do perform a comparison to the S&P 500 and measure the stock's performance against the S&P's performance (see the chart below).
Contact me at TradingComputers.com if you are interested in this indicator.
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