The Failure of Single Time-Frame Analysis Based Indicators to Have Any Predictive Value In Assessing Market Direction.

Indicators that only utilize price action on your trading chart to create their plots are notoriously bad for predicting the future movement of financial instruments. It does not matter if you are examining an oscillator, MACD or volume based indicator, like On-Balance-Volume. These indicators calculate lines based on data inserted into their respective formulas, all of which comes from the time frame you are trading. In essence, price drives the indicator, the indicator does not drive price. If the indicator is devoid of any ability to influence price then by mathematic theorem it cannot predict future price movement.

Let’s take a look at an example:

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In the above example we use RSI as our oscillator. We see that RSI moves into overbought territory: so what impact does that have on price? If RSI effected price, it would start to fall. But since it does not, price just continues to rise. In this case the overbought status of the indicator has absolutely no predictive value in assessing the future movement of price.

 

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In this example, we see RSI making lower highs and price making higher highs: this is known as divergence and it should be heralded with a fall in price. Instead, price moves sideways for a few candles and then continues up: the divergence signal fails. Again, since RSI has no effect on price it cannot have the ability to predict future price movement.

Given this conundrum, what is a trader to do in order to predict the future price movement of a trading instrument? The answer is this: use indicators that are driven by the price action on higher time frames or other markets and remain totally unaffected by price action on your trading chart. The results of these types of indicator analyses will have an effect on the price action of your trading chart.

Let’s look at an example:

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In the above example the pink background is created by an indicator that assess market direction, market structure and support/resistance levels on two higher time frames and projects the results onto your trading chart. Price action on your trading chart does not influence this indicator in any way.

You can see that the results of its analysis do effect price action on your trading chart. If the trend is down on two higher time frames, if all resistance to the downside has been broken on two higher time frames and price action suggests downward movement on two higher time frames then this indicator has significant predictive value in determining the direction of price movement on your trading chart. You can see, that the pink background influences and therefore can predict the downward movement in price.

Let’s take another example:

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Just as higher time frames have significant predictive value on the direction of price on your trading chart, so do multiple quantitative correlative markets. Let me define this term. In the above case we are looking at a chart of the 30-year bond. When price goes up so does the price of other markets. To put it another way, these two markets correlate in price. If they do so 70% of the time or greater this market gets added to our Quant Analysis Indicator. If a markets correlate in direction 90% of the time it is more heavily weighted, or quantified: thus the name, quant analysis indicator.

You can see in the above example that when correlative markets rise and the indicator goes green (1 line –good, 2 lines-better) the price of bonds rises. The direction of price on your trading chart in no way effects the direction of this indicator. This indicator drives price, not the other way around. Thus, it has significant predictive value in determining the direction of price on your trading chart.

In summary, indicators that assimilate data from your trading chart have little predictive value (if any) in determining future market direction. In this case, price drives the indicator, the indicator does not drive price. Indicators that assess data from higher times or other correlative markets and project the results onto your trading chart have significant predictive value in determining price direction. In this instance, the indicator drives price, price does not drive the indicator. Indicators such as these are guaranteed to improve trading results.