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Saturday, October 23, 2021

How to Tweak & Sync Indicator Settings? (and Why should I care?)

How to Tweak & Sync Indicator Settings? (and Why should I care?)

This post is dedicated to exploring and reviewing key concepts specific to configuring technical indicators - these concepts may be obvious to those who have been doing charting and technical analysis for a long time, but hopefully useful to some who are new to charting and the world of technical indicators.

Also once we are familiar with these concepts, we are able to leverage them with almost any chart setup, any indicator, any trading style, any timeframe - or choose not to use them at all - or to partially use them - we will have the necessary background to make an intentional decision to develop our own configurations.

in this exercise, we will attempt to answer few -but very common- questions:
1. what are the best settings i should use for my indicator(s) ?
2. what are "correlated indicators" ?
3. Why should i use indicators on the chart - The price action has all the information i need.

First a quick, fun exercise............. What's wrong with the above chart ?

Nothing, right? we're looking at a daily chart of the Q's - we're using 3 of the most famous (built-in) indicators: The Moving Average Ribbon - on the price panel- and the MACD and the RSI - on lower panels- all 3 indicators are used with default settings (you may say "no one does that?" - we will for now - just for the sake of the exercise, and to explain couple of concepts, so hold that thought).

(for this exercise, assume i am a QQQ trader who traders the daily timeframe . I open and hold positions for few days to few weeks)

Now, let's use the chart above to identify long or short trades based first on the MA cross-over (looking at the 2 faster MA's in the ribbon) and check for confirmation from the MACD and the RSI in the lower panels. Should be easy, right ? we'll start by marking the MA cross-overs with a vertical line that cuts thru the MACD and RSI and see what we get.

here's the chart showing this part of our exercise

snapshot

we have found 4 possible trade setups, based on the (2 fast) MA cross-overs on the price panel - but when looking for confirmation from MACD and the RSI , we ended up with 3 with confusing signals and 1 that's a "Maybe Long" (... if you find yourself in this situation -regardless of what is being traded or the timeframe, then hopefully this post may help)

Question 1: So how to tweak and sync my indicator settings to get good, reliable trading signals across multiple indicators?

there are 3 steps to answer that question and get our "no confusion" chart setup completed.

Step 1: identify your trader's preferred timeframe and trader's time horizon
let's quickly review these 2 core concepts

a. The Traders Preferred Timeframe
each trader has one (or more) preferred timeframe that works best for what and how they trade (full-time vs part-time, stocks, futures , forex, options, crypto..etc etc), their trading style, their risk appetite and tolerance, their capital, and some other variables.

the first thing i need to determine is what is my preferred timeframe. for example, for me, it is the daily (1D) - i have tried the hourly, the 10min, and also the weekly...etc before, and i found i am much more comfortable with the 1D timeframe. it suits my trading style and goals - i have enough time to adjust trades, don't need to watch charts all the time...and many other reasons.

so 1st requirement: identify preferred trader timeframe: daily (check!) (what is your preferred trader timeframe?)

b. the trader's "time horizon"
with the preferred timeframe identified, the next step is to define what is my short, medium, and long time horizon i need to be watching and analyzing to make trading decisions (others may call this something else, let's call it the time horizon)

for example, as a day traders, who trades only stocks and basic options, i need to look at the price action for the current week, 2 weeks and 4 weeks (almost a month) - that doesn't mean i won't look at charts that show price action for a whole year, or an hourly - but for making a trade decision, the price action for this week and this month are what i need to check the most

there, we just solved 2nd requirement - my time horizon
let's express this in terms of my timeframe: 1 week = 5 daily bars, 2 weeks = 10 daily bars, and 4 weeks = 20 daily bars (check!)
(what are your short, medium and long time horizons as expressed in units of your preferred trader timeframe?)

from the above exercise, i identified that i need my indicators to be set to 5, 10 and 20 on a daily chart . this is going to be the most comfortable and relevant settings *for me* to support my trading decision according to *the way I trade*

Step 2:
Ok, so now let's tweak and sync our indicators in the above chart and see if that improves my ability to find possible trades
we'll set the MA ribbon to 5, 10, 20, 50 - we set the MACD to 5 and 10 (don't worry about the MACD smoothing/signal - let's make it 4) - and we set the RSI length to 10
make sure we're using the "close" price as the source across all indicators
make sure we're using EMA (vs SMA ) as the moving average type across all indicators whenever possible.

Here's the *same chart* with my indicator settings tweaked and Sync'ed

snapshot

Step 3:
let's make some simple but *really useful* visual enhancements to help us see the chart overall in a "visually clearer" way (this is very useful to the more "visual folks out there) -- here's what we did
- we hide the unused (slower MA's) on the price chart (for now)
- we added an EMA smoothing line on top of the RSI - and made it easier to see (color, width) - hide the underlying RSI itself - you know how to do that trick, right?
- we also tweaked the main MACD line (color, width) to make it stand out - other elements are tweaked to "fade"

Now let's see if it's now easier to find those trades - Here's the same chart with Sync'ed Indicators AND our "visual tweaks"

snapshot

- and voila! we can see 5 trades with signals from all the indicators agreeing and confirming.
All signals are in sync - no "maybe's" and a lot less confusion - and the best things is, all indicators are tweaked to my preferred timeframe and my trader's time horizons.

you can apply the same approach we used here to any other indicators you use. we just used this set as an example and to explain this concept.

Question 2: What are correlated indicators ?
-----------------------------------------------------------------
to answer that question, look at the last chart we arrived at above - Do you see something surprising in that chart?
if you inspect the MACD and the RSI plots, you will find they are - visually and broadly - similar , right? they both cross the base line (0 for MACD and 50 for RSI ) almost at the same places - and the have overall similar "shape" - why is that?

this is because the MACD and RSI when sync'ed and tweaked, are correlated indicators - although the calculation formula is different for each, and ( RSI ) one is a restricted oscillator (+100 / -100) while the other ( MACD ) is not - they both express price momentum - and when tweaked and sync'ed the way we did above, they will (almost) give the same signals. in fact, in our example, all the 3 indicators (the MA pair on the price panel, the MACD and the RSI ) are all correlated - they're all , basically, "saying the same" thing.

what does that mean for me as a trader ?
it means i'm not receiving any "valuable, additional" insights by having 2 (or more) indicators that represent the same price attribute (in this case momentum) - unless,
-- i intentionally want that - and will change settings for one of those indicators to reflect a different "time horizon". for example, i can set the MA pair on top to lengths 20 and 50 - and use the MACD to get signal on the short term (5 and 10) action while the pair on the price chart act as a long-term filter (only take long trades when the MAs agree).
or
-- i start looking at utilizing other technical indicators that provide completely different insights and informs me about other "hidden market action attributes" variables beyond the ones i already have ( volume is an excellent indicator by itself, also can check for indicators of sentiment, strength of move, squeeze...etc) - this is where more technical analysis research will guide the trader - also it's useful to learn from others and what they are using in their trading setups, and asking "why" questions.

there's so much to say in this part - but i will leave it there.. just a teaser and hope i was able to make some of you curious to research this further

Question 3: if price action has everything i need, why do i need technical indicators in the first place?
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- this is a big debate .. for me, the answer is simple - can you drive your can without the dashboard that informs you when you're about to run out of fuel, or that you're exceeding the legal speed limit - or less obvious things, like your engine temperature - or when the engine oil is below the (red) limit. if i do that once, and i still get safely to my destination, it's definitely not a sure sign that this is what i should always do, or how everyone should be driving their cars.

but then again, it doesn't have to get too sophisticated - if, for my preferred time frame and my time horizon, i can see insights that makes it easier for me to quickly understand the price action (like the dashboard in my car), if i can see the trend, strength / momentum, volume supply / demand, and the prevailing sentiment - i guess that would be good enough.

Also, there's that other big topic - that indicators are meant to indicate. again, the dashboard in your car is meant to show these things like fuel, speed, engine temperature and oil level, RPM..etc - but the dashboard will not tell you where to go with the car .. you already have a plan, and that's why you're driving your can in the first place.
so indicators do not trade for us -- and all this exercise above, is in the service of (and a function of) the trading plans and goals that you already have in mind, before looking at any indicators.

in closing, sorry for the long post :) - hope this post helps inspire some fellow traders to further improve the way they trade.
please trade safely.


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