Increasing the Odds with High Probability Trade Setups
By Simon Maierhofer, ISpyETF.com
If you’ve been trading or investing for a while, you’ve experienced that most trading systems are not what they are cracked up to be. Many fall in the category ‘over-promised, but under-delivered.’
The cruel reality is that there is no crystal ball. Even some of the best systems and strategies are right only 60%+/- of the time. Those odds are often embellished with the claim that winning trades are much bigger than losing trades.
The problem with ‘one trick pony’ systems is that they are usually based on only one strategy, such as: Candle sticks, chart patterns, supply & demand, volume, momentum crossovers, investor sentiment, seasonality, Elliott Wave Theory, etc.
Wouldn’t it make sense to combine various stand-alone indicators into a more reliable composite signal mechanism?
This approach is more time and knowledge intensive, but it would yield more winners. Many traders and investors are willing to sacrifice quantity for quality and ultimately increase the odds of a winning trade.
The image below illustrates how multiple levels of indicators can increase the odds of a winning trade.
Composite Indicator Approach
Let’s suppose the S&P 500 just lost 5% (as before the election) and looks oversold.
A quick scan of various breadth and momentum gauges shows a bullish divergence, and the S&P 500 is just above technical support. Based on Elliott Wave Theory, the S&P may have just completed a corrective decline.
Is it time to buy? Or will stocks roll over into a meltdown?
Why not crosscheck the bullish implication of various technical gauges against other indicators, such as money flow, seasonality, and investor sentiment?
If all indicators point in the same direction (up), it’s obviously a good time to buy. This doesn’t guarantee a winning trade, but it significantly increases the odds of a winning trade (in my experience from about 60% to about 80%).
The chart below shows how it looks when a number of indicators point in the same direction.
The first graph represents the S&P 500, which is plotted against supply & demand (a money flow indicator), seasonality and investor sentiment.
The blue bar highlights that the S&P 500 reached support against a bullish money flow divergence. This means that the market is getter stronger internally even though trade has fallen to a new low.
Seasonality was about to get strongly bullish.
Investor sentiment was extremely bearish, which is bullish for stocks (sellers have been exhausted.
This is an actual real life example. It happened in October 2011. The Profit Radar Report issued a buy signal when the S&P 500 traded at 1,100.
The financial advisory industry often emphasizes the importance of asset allocation and diversification. Why? Because some assets boom while others bust, but they don’t know which one will boom or bust so they advocate owning them all.
This is putting the cart before the horse. Research diversification (looking at all market moving indicators) allows investors to identify high probability trade setups and avoid high-risk markets.
This approach got investors out of gold when it traded around $1,900/oz in 2011 and out of Treasuries in July. It also got investors back into stocks in February, when the S&P traded near 1,800.
Trimming high-risk sectors or asset classes and increasing exposure to low-risk assets is common sense, but under-appreciated.
Crabs in a Bucket – Knowledge vs Emotion
When you buy a bucket of crabs for your backyard boil, you never need a lid. Why? As soon as one crab crawls to the top, the others pull him back down.
This has been the most hated bull market in history, and as soon as someone got bullish and wants to buy, the media started warning of an impending crash.
You probably notices this yourself, but here are just a few headlines from recent years:
March 2013: “Dow Breaks Record, but Party Unlikely to Last” – CNBC
June 2014: “Common Sense Says: Look out for a Market Top” – Yahoo!Finance
June 2014: “This Market is a Ticking Time Bomb” – CNBC
March 2015: “If ever there was a Time for a Stock Sell Signal, it’s now” – MarketWatch
February 2016: “Ok, it’s Official: The Dow is in a Bear Market” – MarketWatch
A man who wants to lead the orchestra must turn his back on the crowd, and an investor who wants to profit must tune out the media noise.
Like a broken record, the Profit Radar Report has been sounding messages, like this one from July 13, 2014:
“Here’s a message for everyone vying to be the next Roubini: A watched pot doesn’t boil and a watched bubble doesn’t burst. The stock market is not yet displaying the classic warning signs of a major top. There will be a correction, but the bull market won’t be over until most bears turn into bulls or the media stops listening to crash prophets.”
Major Market Top Indicator
The risk of a major market top and subsequent crash should be an important risk factor for every investor. However, selling to early (like in 2013) results in an immense loss of opportunity (missed profits).
There is one indicator that correctly foreshadowed the 1987, 2000 and 2007 market crashes. This indicator says that the bull market still has more room to roar (more detail on this indicator is available here).
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Simon Maierhofer monitors various technical indicators like money flow, investor sentiment, seasonality, cycles and dozens of other indicators to identify high probability or low-risk setups. He shares his research, analysis, forecasts and trading recommendation at least twice a week via the Profit Radar Report.