Computers and Trading Systems
posted under
Philosophy of Technical Analysis
by ceecabolos
$INTRODUCTION$
The computer has played an increasingly important role in the field of technical analysis. In this chapter, we'll see how the computer can make the technical trader's task a good deal easier by providing quick and easy access to an arsenal of technical tools and studies that would have required an enormous amount of work just a few years earlier. This assumes, of course, that the trader knows how to use these tools, which brings us to one of the disadvantages of the computer.
The trader not properly schooled in the concepts that underlie the various indicators, and who is not comfortable with how each indicator is interpreted, may find him- or herself overwhelmed with the vast array of computer software currently available. Even worse, the amount of impressive technical data at one's fingertips sometimes fosters a false sense of security and competence. Traders mistakenly assume that they are automatically better simply because they have access to so much computer power.
The theme emphasized in this discussion is that the computer is an extremely valuable tool in the hands of a technically oriented trader who has already done his or her basic homework. When we review many of the routines available in the computer, you'll see that a fair number of the tools and indicators are quite basic and have already been covered in previous chapters. There are, of course, more sophisticated tools that require more advanced charting software.
Much of the work involved in technical analysis can be performed without the computer. Certain functions can be more easily performed with a simple chart and ruler than with a computer printout. Some types of longer range analysis don't require a computer. As useful as it is, the computer is only a tool. It can make a good technical analyst even better. It won't, however, turn a poor technician into a good one.
Charting Software
Several of the technical routines available in charting software have been covered in previous chapters. We'll review some of the tools and indicators currently available. We'll then address some additional features such as the ability to automate the various functions chosen by the user. In addition to providing us with the various technical studies, the computer also enables us to test various studies for profitability, which may be the most valuable feature of the program. Some software allows the user, with little or no programming background, to construct indicators and systems.
Welles Wilder's Directional Movement and Parabolic Systems
We'll take a close look at a couple of Welles Wilder's more popular systems, the Directional Movement System and the Parabolic System. We'll use those two systems in our discussion of the relative merits of relying on mechanical trading systems. It will be demonstrated that mechanical trend following systems only work well in certain types of market environments. It will also be shown how a mechanical system can be incorporated into one's market analysis and used simply as a confirming technical indicator.
Too Much of a Good Thing
It may strike you that there are too many indicators from which to choose. Instead of simplifying our lives, has the computer only served to complicate things by giving us so much more to look at? Charting packages offer 80 different studies that are available to the technician. How does one possibly reach any conclusions (and find the time to trade) with so much data to contend with? We'll say a few words about some work being done in that direction.
SOME COMPUTER NEEDS
Charting software can be applied to virtually any financial market. Most software is user-friendly, meaning that it can be easily implemented by choosing from successive lists of available routines. The place to start is with a charting software package that works for the computer you already own or are thinking of buying. Bear in mind that most charting software has been written for IBM-compatible computers.
Charting packages do not provide daily market data. The user must obtain that data elsewhere. Data can be collected automatically from a data service over telephone lines (requiring a phone modem). Charting packages provide the names of various data vendors from which to choose. These data vendors provide all the software and instructions needed to set up and collect the data files.
When first starting out, the user must collect historical data going back for at least several months to have something to work with. After that, data should be collected daily. It is possible to analyze "on line" data during the trading day by hooking up to a quote service. However, in our use of daily data, we will be referring to end-of-day data, which is available after the markets close. The final piece of equipment you might want is a printer to obtain a copy of whatever appears on the terminal screen. CD-Rom capability is highly recommended since some software vendors provide you with several years of historical data on a CD-Rom disk to
get you started. There are some data vendors that also provide charting capability, which simplifies your task even more. One such service is Telescan (5959 Corporate Drive, Suite 2000, Houston, TX 77036, (800) 324-8246, www.telescan.com).
GROUPING TOOLS AND INDICATORS
The following list groups some of the chart and indicator options.
· Basic Charts: Bar, line, point and figure, and candlesticks
· Chart Scales: Arithmetic and semilogarithmic
· Bar Chart: Price, volume, and open interest (for futures)
· Volume: Bars, on balance, and Demand Index
· Basic Tools: Trendlines and channels, percentage retracements, moving averages, and oscillators
· Moving Averages: Reference envelopes, Bollinger Bands
· Oscillators: Commodity Channel Index, momentum, rate of change, MACD, Stochastic, Williams %R, RSI
· Cycles: Cycle Finder
· Fibonacci Tools: Fan lines, arcs, time zones and retracements
· Wilder: RSI, Commodity Selection Index, Directional Movement, Parabolic, Swing Index, ADX line
USING THE TOOLS AND INDICATORS
How does one cope with so much from which to choose? A suggestion is to first use the basic tools such as price, volume, trend-lines, percentage retracements, moving averages, and oscillators. Notice the large number of oscillators available. Pick one or two that you are most comfortable with and go with them. Use such things as cycles and Fibonacci tools as secondary inputs unless you have a special interest in those areas. Cycles can help fine
tune moving average and oscillator lengths, but require study and practice. For mechanical trading systems, Wilder's Parabolic and DMI are especially noteworthy.
WELLES WILDER'S PARABOLIC AND DIRECTIONAL
MOVEMENT SYSTEMS
We're going to spend some time on two studies that are especially useful. Both studies were developed by J. Welles Wilder Jr. and discussed in his book, New Concepts in Technical Trading Systems. Three of Wilder's other studies included on the computer menu—Commodity Selection Index, Relative Strength Index, and the Swing Index—are also included in the same book.
Parabolic System (SAR)
Wilder's Parabolic system (SAR) is a time/price reversal systemthat is always in the market. The letters "SAR" stand for "stop andreverse," meaning that the position is reversed when the protec‑tive stop is hit. It is a trend-following system. It gets its name fromthe shape assumed by the trailing stops that tend to curve like aparabola. (See Figures 15.1-15.4. Notice that as prices trend high‑er, the rising dots below the price action (the stop and reversepoints) tend to start out slower and then accelerate with thetrend. In a downtrend, the same thing happens but in the oppo‑site direction (the dots are above the price action). The SAR num‑bers are calculated and available to the user for the following day.Wilder built an acceleration factor into the system. Eachday the stop moves in the direction of the new trend. At first, themovement of the stop is relatively slow to allow the trend time tobecome established. As the acceleration factor increases, the SARbegins to move faster, eventually catching up to the price action.If the trend falters, or fails to materialize, the result is usually a stopand reverse signal. As the accompanying charts show, theParabolic system works extremely well in trending markets. Noticethat while the trending portions were captured well, the systemwhipsawed constantly during the sideways, nontrending periods.Because the ADX line is on a scale from 0 to 100, the trend trader could simply trade those markets with the highest trend ratings. Nontrending systems (oscillators, for example) could be utilized on markets with low directional movement.
Directional Movement can be used either as a system on its own or as a filter on the Parabolic or any other trend-following system. Two lines are generated in the DMI study, +DI and -DI. The first line measures positive (upward) movement and the second number, negative (downward) movement). Figure 15.6 shows the two lines. The darker line is + DI and the lighter line -DI. A buy signal is given when the +DI line crosses over the - DI line and a sell signal when it crosses below the - DI line.
Figure 15.6 also shows both the Parabolic and Directional Movement systems. The Parabolic is clearly a more sensitive sys‑tem, meaning that more frequent and earlier signals are given. However, by using the Directional Movement as a filter, several of the bad signals in the Parabolic could be avoided by following only those signals in the same direction as the Directional Movement lines. It appears then that the Parabolic and Directional Movement systems should be used together, with Directional Movement acting as a screen or filter on the more sensitive Parabolic.
The best time to use a trending system is when the ADX line is rising. (See Figures 15.7 and 15.8.) Be forewarned, however, that when the ADX line starts to drop from above the 40 level, that is an early sign that the trend is weakening. A rise back above the 20 level is often a sign of the start of a new trend. (The ADX line is essentially a smoothed difference between the +DI and —DI lines.)
PROS AND CONS OF SYSTEM TRADING
Advantages of Mechanical Systems
1. Human emotion is eliminated.
2. Greater discipline is achieved.
3. More consistency is possible.
4. Trades are taken in the direction of the trend.
5. Participation is virtually guaranteed in the direction of every important trend.
6. Profits are allowed to run. 7. Losses are minimized.
Disadvantages of Mechanical Systems
1. Most mechanical systems are trend-following.
2. Trend-following systems rely on major trends in order to be profitable.
3. Trend-following systems are generally nonprofitable when markets are not trending.
4. There are long periods of time when markets are not trending and, therefore, not suitable for a trending approach.
The major problem is the failure of the system to recognize when the market is not trending and its inability to turn itself off. The measure of a good system is not only its ability to make money in trending markets, but its ability to preserve capital during nontrending periods. It is this inability of the system to monitor itself that is its greatest weakness. This is where some overriding filtering device, such as Welles Wilder's Directional Movement system or the ADX line could prove especially useful by allowing the trader to determine which markets are most suitable for a trending system.
Another drawback is that no allowance is generally made for anticipating market reversals. Trend-following systems ride with the trend until it turns. They don't recognize when a market has reached a long term support or resistance level, when oscillator divergences are being given, or when an Elliott Wave fifth pattern is clearly visible. Most traders would get more defensive at that point, and begin taking some profits. The system, however, will stay with the position until well after the market has changed direction. Therefore, it's up to the trader to determine how best to employ the system. That is to say, whether it should be followed blindly or whether it should be incorporated into a trading plan with other technical factors. That brings us to our next section on how a mechanical system can be used as just another technical input into the forecasting and trading process.
Using System Signals as a Disciplining Device
The system signals can be used simply as a mechanical confirmation along with other technical factors. Even if the system is not being traded mechanically, and other technical factors are being employed, the signals could be used as a disciplined way to keep the trader on the right side of the major trend. No short positions would be taken as long as the computer trend was up. No longs would be taken in a computer downtrend. (This would be a simple way for fundamentally oriented traders to use a technical device as a filter or trigger on their own trading ideas.) Trend direction can be a matter of judgment. The computer signals relieve the trader of some degree of uncertainty. They can prevent him or her from falling into the trap of "top and bottom picking."
Using Signals as Alerts
System signals can also be used as an excellent screening device to alert the trader to recent trend changes. The trader can simply glance at the trend signals and instantly has several trading candidates. The same information could be found by studying all of the charts. The computer just makes that task quicker, easier, and more authoritative. The ability of the computer to automate system signals and then alert the trader when signals are triggered is an enormous asset, especially when the universe of financial markets has grown so large.
NEED EXPERT HELP?
One of the products offered by Omega Research called TradeStation offers a variety of Expert Features (Omega Research, Miami, FL 33174, (305) 551-9991). You can call up its Expert Commentary, which interprets indicators for you based on current market conditions. Omega's Expert Analyst will determine
which indicators should work best in the current market and interpret them for you. In addition, it has two Expert Tools. The Trendlines Automatic Indicator actually draws trendlines for you. The Candlestick Patterns Indicator reads the more common candlestick chart patterns.
TEST SYSTEMS OR CREATE YOUR OWN
Omega Research also includes a library of the most popular trading systems used by traders. You can test them, change them, or create your own if you wish. All of Omega's charting tools, indicators, and trading systems are written in a relatively simple language called EasyLanguage. EasyLanguage takes trading ideas that you have described in plain language and converts them into the machine code needed to run the program. It's hard to overestimate the value of being able to develop, test, optimize if you wish, and then automate your own trading ideas—without being a computer programmer. The computer will even generate the appropriate trading orders for you and alert you via your alphanumeric pager that signals have been triggered. (In Appendix C, we'll use Omega Research's EasyLanguage and TradeStation to show you how to go about creating a trading system of your own.)
CONCLUSION
This chapter introduced a couple more of Welles Wilder's systems to you—Parabolics and Directional Movement (DMI). Parabolics can generate useful trading signals, but probably shouldn't be used alone. The two Dl lines can be used as a filter on Parabolics or any other sensitive trend-following trading system. The ADX line, which is part of the DMI system, provides one way to determine which type of market you're dealing with—a trending or a trading market. A rising ADX line suggests a trend and favors moving averages. A falling ADX line suggests a trading range and favors oscillators. We also used the Parabolic examples to show
the good and bad sides of most trend-following systems. They work well when a trend is present. They're useless during a trading range. You have to be able to tell the difference. We also touched on the merits of mechanical trading systems. These systems remove human emotion and can be very helpful in the right market climate. They can also be used as technical alerts and used in conjunction with fundamental analysis. (See Appendix C for more on system trading.)
There's no question that the computer has revolutionized financial market analysis and trading. While our interest is primarily in technical analysis, software programs also allow you to blend fundamental analysis with the technical. When the first edition of this book was published in 1986, it cost about $5,000 to outfit yourself with the necessary computer hardware to perform serious technical analysis. The leading software package of the day cost close to $2,000. How things have changed. You can now obtain incredibly powerful computers for less than $2,000. Most software packages can be had for less than $300. The better ones provide you with up to 20 years of historical price data on a CD-Rom disk at little or no additional cost.
Another big benefit is the amount of educational help that you can obtain with those software packages. The user manuals alone are the size of a book and include technical formulas and all kinds of useful explanations. The screening and alert capabilities of today's computer are especially helpful to those monitoring global bond and stock markets and thousands of individual common stocks, not to mention mutual funds. In Chapter 17, we'll talk about an even more sophisticated use of computer technology for developing neural networks. But the message to you is clear. If you are serious about investing or trading financial markets, get a computer and learn how to use it. You'll be glad you did.
The computer has played an increasingly important role in the field of technical analysis. In this chapter, we'll see how the computer can make the technical trader's task a good deal easier by providing quick and easy access to an arsenal of technical tools and studies that would have required an enormous amount of work just a few years earlier. This assumes, of course, that the trader knows how to use these tools, which brings us to one of the disadvantages of the computer.
The trader not properly schooled in the concepts that underlie the various indicators, and who is not comfortable with how each indicator is interpreted, may find him- or herself overwhelmed with the vast array of computer software currently available. Even worse, the amount of impressive technical data at one's fingertips sometimes fosters a false sense of security and competence. Traders mistakenly assume that they are automatically better simply because they have access to so much computer power.
The theme emphasized in this discussion is that the computer is an extremely valuable tool in the hands of a technically oriented trader who has already done his or her basic homework. When we review many of the routines available in the computer, you'll see that a fair number of the tools and indicators are quite basic and have already been covered in previous chapters. There are, of course, more sophisticated tools that require more advanced charting software.
Much of the work involved in technical analysis can be performed without the computer. Certain functions can be more easily performed with a simple chart and ruler than with a computer printout. Some types of longer range analysis don't require a computer. As useful as it is, the computer is only a tool. It can make a good technical analyst even better. It won't, however, turn a poor technician into a good one.
Charting Software
Several of the technical routines available in charting software have been covered in previous chapters. We'll review some of the tools and indicators currently available. We'll then address some additional features such as the ability to automate the various functions chosen by the user. In addition to providing us with the various technical studies, the computer also enables us to test various studies for profitability, which may be the most valuable feature of the program. Some software allows the user, with little or no programming background, to construct indicators and systems.
Welles Wilder's Directional Movement and Parabolic Systems
We'll take a close look at a couple of Welles Wilder's more popular systems, the Directional Movement System and the Parabolic System. We'll use those two systems in our discussion of the relative merits of relying on mechanical trading systems. It will be demonstrated that mechanical trend following systems only work well in certain types of market environments. It will also be shown how a mechanical system can be incorporated into one's market analysis and used simply as a confirming technical indicator.
Too Much of a Good Thing
It may strike you that there are too many indicators from which to choose. Instead of simplifying our lives, has the computer only served to complicate things by giving us so much more to look at? Charting packages offer 80 different studies that are available to the technician. How does one possibly reach any conclusions (and find the time to trade) with so much data to contend with? We'll say a few words about some work being done in that direction.
SOME COMPUTER NEEDS
Charting software can be applied to virtually any financial market. Most software is user-friendly, meaning that it can be easily implemented by choosing from successive lists of available routines. The place to start is with a charting software package that works for the computer you already own or are thinking of buying. Bear in mind that most charting software has been written for IBM-compatible computers.
Charting packages do not provide daily market data. The user must obtain that data elsewhere. Data can be collected automatically from a data service over telephone lines (requiring a phone modem). Charting packages provide the names of various data vendors from which to choose. These data vendors provide all the software and instructions needed to set up and collect the data files.
When first starting out, the user must collect historical data going back for at least several months to have something to work with. After that, data should be collected daily. It is possible to analyze "on line" data during the trading day by hooking up to a quote service. However, in our use of daily data, we will be referring to end-of-day data, which is available after the markets close. The final piece of equipment you might want is a printer to obtain a copy of whatever appears on the terminal screen. CD-Rom capability is highly recommended since some software vendors provide you with several years of historical data on a CD-Rom disk to
get you started. There are some data vendors that also provide charting capability, which simplifies your task even more. One such service is Telescan (5959 Corporate Drive, Suite 2000, Houston, TX 77036, (800) 324-8246, www.telescan.com).
GROUPING TOOLS AND INDICATORS
The following list groups some of the chart and indicator options.
· Basic Charts: Bar, line, point and figure, and candlesticks
· Chart Scales: Arithmetic and semilogarithmic
· Bar Chart: Price, volume, and open interest (for futures)
· Volume: Bars, on balance, and Demand Index
· Basic Tools: Trendlines and channels, percentage retracements, moving averages, and oscillators
· Moving Averages: Reference envelopes, Bollinger Bands
· Oscillators: Commodity Channel Index, momentum, rate of change, MACD, Stochastic, Williams %R, RSI
· Cycles: Cycle Finder
· Fibonacci Tools: Fan lines, arcs, time zones and retracements
· Wilder: RSI, Commodity Selection Index, Directional Movement, Parabolic, Swing Index, ADX line
USING THE TOOLS AND INDICATORS
How does one cope with so much from which to choose? A suggestion is to first use the basic tools such as price, volume, trend-lines, percentage retracements, moving averages, and oscillators. Notice the large number of oscillators available. Pick one or two that you are most comfortable with and go with them. Use such things as cycles and Fibonacci tools as secondary inputs unless you have a special interest in those areas. Cycles can help fine
tune moving average and oscillator lengths, but require study and practice. For mechanical trading systems, Wilder's Parabolic and DMI are especially noteworthy.
WELLES WILDER'S PARABOLIC AND DIRECTIONAL
MOVEMENT SYSTEMS
We're going to spend some time on two studies that are especially useful. Both studies were developed by J. Welles Wilder Jr. and discussed in his book, New Concepts in Technical Trading Systems. Three of Wilder's other studies included on the computer menu—Commodity Selection Index, Relative Strength Index, and the Swing Index—are also included in the same book.
Parabolic System (SAR)
Wilder's Parabolic system (SAR) is a time/price reversal systemthat is always in the market. The letters "SAR" stand for "stop andreverse," meaning that the position is reversed when the protec‑tive stop is hit. It is a trend-following system. It gets its name fromthe shape assumed by the trailing stops that tend to curve like aparabola. (See Figures 15.1-15.4. Notice that as prices trend high‑er, the rising dots below the price action (the stop and reversepoints) tend to start out slower and then accelerate with thetrend. In a downtrend, the same thing happens but in the oppo‑site direction (the dots are above the price action). The SAR num‑bers are calculated and available to the user for the following day.Wilder built an acceleration factor into the system. Eachday the stop moves in the direction of the new trend. At first, themovement of the stop is relatively slow to allow the trend time tobecome established. As the acceleration factor increases, the SARbegins to move faster, eventually catching up to the price action.If the trend falters, or fails to materialize, the result is usually a stopand reverse signal. As the accompanying charts show, theParabolic system works extremely well in trending markets. Noticethat while the trending portions were captured well, the systemwhipsawed constantly during the sideways, nontrending periods.Because the ADX line is on a scale from 0 to 100, the trend trader could simply trade those markets with the highest trend ratings. Nontrending systems (oscillators, for example) could be utilized on markets with low directional movement.
Directional Movement can be used either as a system on its own or as a filter on the Parabolic or any other trend-following system. Two lines are generated in the DMI study, +DI and -DI. The first line measures positive (upward) movement and the second number, negative (downward) movement). Figure 15.6 shows the two lines. The darker line is + DI and the lighter line -DI. A buy signal is given when the +DI line crosses over the - DI line and a sell signal when it crosses below the - DI line.
Figure 15.6 also shows both the Parabolic and Directional Movement systems. The Parabolic is clearly a more sensitive sys‑tem, meaning that more frequent and earlier signals are given. However, by using the Directional Movement as a filter, several of the bad signals in the Parabolic could be avoided by following only those signals in the same direction as the Directional Movement lines. It appears then that the Parabolic and Directional Movement systems should be used together, with Directional Movement acting as a screen or filter on the more sensitive Parabolic.
The best time to use a trending system is when the ADX line is rising. (See Figures 15.7 and 15.8.) Be forewarned, however, that when the ADX line starts to drop from above the 40 level, that is an early sign that the trend is weakening. A rise back above the 20 level is often a sign of the start of a new trend. (The ADX line is essentially a smoothed difference between the +DI and —DI lines.)
PROS AND CONS OF SYSTEM TRADING
Advantages of Mechanical Systems
1. Human emotion is eliminated.
2. Greater discipline is achieved.
3. More consistency is possible.
4. Trades are taken in the direction of the trend.
5. Participation is virtually guaranteed in the direction of every important trend.
6. Profits are allowed to run. 7. Losses are minimized.
Disadvantages of Mechanical Systems
1. Most mechanical systems are trend-following.
2. Trend-following systems rely on major trends in order to be profitable.
3. Trend-following systems are generally nonprofitable when markets are not trending.
4. There are long periods of time when markets are not trending and, therefore, not suitable for a trending approach.
The major problem is the failure of the system to recognize when the market is not trending and its inability to turn itself off. The measure of a good system is not only its ability to make money in trending markets, but its ability to preserve capital during nontrending periods. It is this inability of the system to monitor itself that is its greatest weakness. This is where some overriding filtering device, such as Welles Wilder's Directional Movement system or the ADX line could prove especially useful by allowing the trader to determine which markets are most suitable for a trending system.
Another drawback is that no allowance is generally made for anticipating market reversals. Trend-following systems ride with the trend until it turns. They don't recognize when a market has reached a long term support or resistance level, when oscillator divergences are being given, or when an Elliott Wave fifth pattern is clearly visible. Most traders would get more defensive at that point, and begin taking some profits. The system, however, will stay with the position until well after the market has changed direction. Therefore, it's up to the trader to determine how best to employ the system. That is to say, whether it should be followed blindly or whether it should be incorporated into a trading plan with other technical factors. That brings us to our next section on how a mechanical system can be used as just another technical input into the forecasting and trading process.
Using System Signals as a Disciplining Device
The system signals can be used simply as a mechanical confirmation along with other technical factors. Even if the system is not being traded mechanically, and other technical factors are being employed, the signals could be used as a disciplined way to keep the trader on the right side of the major trend. No short positions would be taken as long as the computer trend was up. No longs would be taken in a computer downtrend. (This would be a simple way for fundamentally oriented traders to use a technical device as a filter or trigger on their own trading ideas.) Trend direction can be a matter of judgment. The computer signals relieve the trader of some degree of uncertainty. They can prevent him or her from falling into the trap of "top and bottom picking."
Using Signals as Alerts
System signals can also be used as an excellent screening device to alert the trader to recent trend changes. The trader can simply glance at the trend signals and instantly has several trading candidates. The same information could be found by studying all of the charts. The computer just makes that task quicker, easier, and more authoritative. The ability of the computer to automate system signals and then alert the trader when signals are triggered is an enormous asset, especially when the universe of financial markets has grown so large.
NEED EXPERT HELP?
One of the products offered by Omega Research called TradeStation offers a variety of Expert Features (Omega Research, Miami, FL 33174, (305) 551-9991). You can call up its Expert Commentary, which interprets indicators for you based on current market conditions. Omega's Expert Analyst will determine
which indicators should work best in the current market and interpret them for you. In addition, it has two Expert Tools. The Trendlines Automatic Indicator actually draws trendlines for you. The Candlestick Patterns Indicator reads the more common candlestick chart patterns.
TEST SYSTEMS OR CREATE YOUR OWN
Omega Research also includes a library of the most popular trading systems used by traders. You can test them, change them, or create your own if you wish. All of Omega's charting tools, indicators, and trading systems are written in a relatively simple language called EasyLanguage. EasyLanguage takes trading ideas that you have described in plain language and converts them into the machine code needed to run the program. It's hard to overestimate the value of being able to develop, test, optimize if you wish, and then automate your own trading ideas—without being a computer programmer. The computer will even generate the appropriate trading orders for you and alert you via your alphanumeric pager that signals have been triggered. (In Appendix C, we'll use Omega Research's EasyLanguage and TradeStation to show you how to go about creating a trading system of your own.)
CONCLUSION
This chapter introduced a couple more of Welles Wilder's systems to you—Parabolics and Directional Movement (DMI). Parabolics can generate useful trading signals, but probably shouldn't be used alone. The two Dl lines can be used as a filter on Parabolics or any other sensitive trend-following trading system. The ADX line, which is part of the DMI system, provides one way to determine which type of market you're dealing with—a trending or a trading market. A rising ADX line suggests a trend and favors moving averages. A falling ADX line suggests a trading range and favors oscillators. We also used the Parabolic examples to show
the good and bad sides of most trend-following systems. They work well when a trend is present. They're useless during a trading range. You have to be able to tell the difference. We also touched on the merits of mechanical trading systems. These systems remove human emotion and can be very helpful in the right market climate. They can also be used as technical alerts and used in conjunction with fundamental analysis. (See Appendix C for more on system trading.)
There's no question that the computer has revolutionized financial market analysis and trading. While our interest is primarily in technical analysis, software programs also allow you to blend fundamental analysis with the technical. When the first edition of this book was published in 1986, it cost about $5,000 to outfit yourself with the necessary computer hardware to perform serious technical analysis. The leading software package of the day cost close to $2,000. How things have changed. You can now obtain incredibly powerful computers for less than $2,000. Most software packages can be had for less than $300. The better ones provide you with up to 20 years of historical price data on a CD-Rom disk at little or no additional cost.
Another big benefit is the amount of educational help that you can obtain with those software packages. The user manuals alone are the size of a book and include technical formulas and all kinds of useful explanations. The screening and alert capabilities of today's computer are especially helpful to those monitoring global bond and stock markets and thousands of individual common stocks, not to mention mutual funds. In Chapter 17, we'll talk about an even more sophisticated use of computer technology for developing neural networks. But the message to you is clear. If you are serious about investing or trading financial markets, get a computer and learn how to use it. You'll be glad you did.
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