Indicator Caveat: Curve-Fit Data

There are literally hundred of technical analysis indicators. Numbers, we learn, have infinite manipulability. But, again, most of them shake out as trading or trending, meaning they do well in one environment, poor in the other.

Most indicators have curve-fit data. You must define one or more price or time variables to calculate the indicator. In a moving average, you must select how many time units to average. The indicator is said to be "curve-fit" to that data. The pre-Socratic philosopher Heraclitus said it best: "You cannot step twice into the same river," and so it is with the FOREX markets.
An instance variable that worked perfectly in one trading session can fail miserably in the next as the market environment changes.

Opinions vary widely on this caveat. Indicators are immensely popular in FOREX. Co-author of the first edition of Getting Started in Currency Trading, Jim Bickford, was a champion of them, whereas I believe they have limited value. Sophisticated indicators should be constructed in such a fashion that the instance variables are adjusted for the changes in market environment.

Indicators tend to be either effective in trading markets or trending markets -- but not both. If you use a battery of indicators, be sure they are evenly divided between trading markets and trending markets for balance. For an excellent discussion of the classic trading versus trending concept, see Forex Patterns and Probabilities, by Ed Ponsi (John Wiley & Sons, 2007). For a discussion of the modern quantified version of trading and trending market environments, see Options and Exotics and Computer Trading.
By Michael Duane Archer
Michael Duane Archer has been an active futures and FOREX trader for more than 35 years. He has worked in various advisory capacities, notably as a commodity trading advisor, registered SEC investment advisor, and branch manager for Heinold of Hawaii. He currently trades FOREX and futures and is involved in several technical analysis research projects.

Copyrighted 2016. Content published with author's permission.

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