Technical Indicators...Are They All They Are Cracked Up To Be?

Ever wake up one day and say, "I want to become a "technical analyst" daytrader, someone who sits in front of the computer all day buying and selling shares of stock or options/futures contracts? Being a novice to trading, you bring up a technical chart, add a couple of indicators such as moving averages or MACD and say to yourself, "this is going to be easy," as you count the money you're going to walk away with, your dreams of wealth finally coming true. But within a few days, all your dreams come to an end, as you see your portfolio drained from loss after loss after loss.

Not to be humbled by Market insults, you run out and purchase a raft of technical indicators, one after the other. Surely amongst all the trading software available on the Market today, there must be one such indicator, one "Holy Grail," the key to fulfilling all your dreams of wealth and riches. But what is the reality? All the hype in all the trading websites, couldn't put Humpty Dumpty together again.

So often we're told about this indicator not working and that indicator not working, as if an individual technical indicator could account for an entire trading system. Trading is a big subject. As for technical indicators? They are merely individual components of an overall trading strategy, not a strategy in and of themselves.

Read the hype in all the websites. Invariably they say, "high probability predictions". That's correct, prediction, not much more than weather forecasts. And if the indicators don't work for you, well, no problem...the developers are never responsible for your loss. Just move on and buy another indicator.

What makes these indicators so inconsistent? They are all based upon the same data, price, volume and time. Surely by now someone could have come up with an indicator that really blends these three elements into a workable strategy, especially given all the mathematicians who, over the years, have worked on them.

The answer to this riddle is simple...high frequency trading robots programs (HFT's). In today's Market, high frequency trading firms represent 2% of the nearly 20,000 trading firms. Yet they account for nearly 73% of all US trades and 40% of all European trades. In 2008, the only computer generated trading came from basket trades executed at 9:30am when the Market opened, and even that was less than 30% of the daily trading volume. In 4 short years, HFT's have garnered an additional 40% of the Market. Think what will happen over the next 4 years.

Here's the real key to why technical indicators are no longer reliable. Technical analysis is based upon the belief that there are predictive patterns that follow overall trends, the underlying idea being that traders tend to buy and sell in repetitive sequences. These sequences can be identified through such tools as moving averages, MACD's, Elliott Waves, Bollinger bands, RSI, ROC, etc. What technical traders haven't realized yet is that HFT's do NOT follow trends; HFT's sacrifice repetition for speed.

Let's put this into perspective. 1 second equals 1000 milliseconds. Every click of a mouse normally requires 300 milliseconds. In the time it takes to click a mouse, HFT's will have had their trades filled by the Exchanges...because HFT trades can get filled in 1 millisecond. Their computers are located inside the Exchanges, directly tied to the Exchange's datafeed. They don't need to watch the old "tried and true" moving averages or MACD's. Their only interest is in waiting for a lightly traded Market, ensuring that there is no competition for their trades to be executed. Compare this to a trader watching technical indicators, waiting for the trend to start, watching, watching, watching.

Here's the rule of thumb. For every 100 miles you live from the Exchange, you'll need at least 2 milliseconds for your trade to arrive, not to get filled, to arrive. Say you live in California and want to buy some shares at the Nasdaq. You click your charting platform, sending the trade on its way. The mouse click alone took 300 milliseconds and you've just added another 30-40 milliseconds for your trade to arrive. By the time your trade arrives at the exchange, the HFT's that were filled earlier in 1-2 milliseconds, use your trade as an exit for theirs. They bought, and now they are selling. Your executions, late to the party, become casualties of war.

No technical indicator can help you overcome HFT's, especially if those indicators were developed pre-2008, before the HFT's took over the majority of trading.

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