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Trade Example (03/2003)

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How to Use Additional Indicators:

Let's assume that you have 5 independent trading indicators that, every day, show you possible future trends for the market. To each indicator you assign a level of importance related to how that particular indicator influences your final decision. Some traders place the majority of their confidence in one indicator and only use other indicators to confirm what they know from their primary indicator. It is YOU who has to decide how to weight these indicators, and which indicators you are going to consider at all. For example, you could have a weighting similar to this:

1^st indicator: 0.55 (55%) - Volume Indicator
2^nd indicator: 0.15 (15%) - Market Newsletters
3^rd indicator: 0.15 (15%) - Other Traders
4^th indicator: 0.1 (10%) - News / Talking Heads
5^th indicator: 0.05 (5%) - Broker

Of course, all of these up to 100 percent.

Now, let us assume that a situation arises on the market for which the first, and highest weighted, indicator shows that the market is likely to move higher. Is this indicator enough to base trading decision upon? Could it be incorrect? The best way to evaluate that indicator is to compare and contrast it with the others in your weighted list. Simply assign a coefficient to each indicator (on a scale of -10 to +10) based on what they predict for the future movements of the market. For example:

1^st indicator: +7
2^nd indicator: -2
3^rd indicator: -3
4^th indicator: 0
5^th indicator: -4

"How do I know what coefficient, or level of confidence to assign an indicator?"
Assigning coefficients to your indicators in an entirely subjective task, which, unfortunately, requires some experience before you master the system. Don't expect to know what level of confidence to assign your first indicator on your first day of using this system. What you assign as a +5 today may be +3 to you after several months of experience.

Don't be afraid to test the system. It cannot work for you until you get a good track record.

After assigning coefficients to your indicators, simply multiply each indicator's coefficient by its weighting and add them together:

(0.55 x 7) + (0.15 x -2) + (0.15 x -3) + (0.1 x 0) + (0.05 x -4) = 2.9

The result is a signal strength of +2.9. Now, unless you have a high risk tolerance, it probably is not a good idea to base a trading decision on an indicator that is in the range of -4 to +4, as this is what we'd call the "uncertainty" range.

But perhaps the next day you assign the following coefficients to your list of indicators:

1^st indicator: +5
2^nd indicator: +6
3^rd indicator: +2
4^th indicator: +4
5^th indicator: +7

Now the summary signal will become:

(0.55 x 5) + (0.15 x 6) + (0.15 x 2) + (0.1 x 4) + (0.05 x 7) = 4.7

In this situation, you are probably more willing to open a long trade. With a confidence rating of only 4.7 (0.7 above the threshold), perhaps you may want to think about only opening a small long position until the confidence grows.

From the above examples, you can see how additional indicators can reduce your trading risk.

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