Info!! Toward A Dynamic Approach To Technical Analysis

In my recent post, I suggested that a dynamic technical analysis would non rely upon a fixed laid of indicators in addition to nautical chart patterns to survive interpreted inwards a uniform manner.  Rather, fresh predictors would arise from a report of drivers impacting the most recent marketplace seat regimes. Traders would follow the indicators that direct maintain demonstrated predictive accuracy; non untested ones presumed to receive universal validity.

Let's accept an illustration from the electrical flow market.  Using tests of stationarity, I direct maintain identified a stable menstruation of marketplace seat demeanour embracing the recent past.  That stability agency that marketplace seat toll changes during that menstruation tin terminate survive assumed to give-up the ghost along from a unmarried process.  If the fourth dimension menstruation nether consideration possessed wildly dissimilar statistical properties, such equally 2008 in addition to 2014 for stocks, thus at that topographic point would survive no assurance that toll changes were resulting from a stable process.  That would plow over us no argue to extrapolate patterns from 1 menstruation to the other.

A major work amongst traditional purpose of technical indicators is that they are employed uniformly across non-stationary periods--especially intraday.

It turns out that during the most recent stationary menstruation (i.e., "regime") a major driver of short-term toll has been correlation.  How SPX is correlated amongst other equity instruments has been significantly predictive of short-term frontward toll change.  

The select deal of is that unmarried measures of correlation were non especially informative inwards my research.  Rather, aggregated correlations across a large pose out of stocks in addition to sectors in addition to over intraday horizons ended upward beingness an first-class stair out for short-term trading signals.  In other words, the most valuable indicator of correlation was non a criterion technical indicator, simply rather a stair out that required research.  Moreover, I had to inquiry it inwards such a way equally to non overfit the information relationship.

But at that topographic point it is:  when the correlation stair out exceeds .40, the side past times side day's toll modify has averaged +.35%.  When the correlation has been below .40, the side past times side day's toll modify has averaged -.37%.  As long equally nosotros rest inwards the electrical flow regime--a primal assumption--I await marketplace seat pull when correlations are high in addition to rising in addition to weakness when they are depression in addition to falling.

That becomes a potential trading "setup" for the electrical flow regime.  In a hereafter regime, correlation may survive much to a greater extent than modestly associated amongst frontward toll change--or it may survive predictive over longer fourth dimension frames.  Setups give-up the ghost dynamic, because they adjust to changing markets.  

But correlation is simply 1 component that sets upward inwards the electrical flow regime.  There are others, from options ratios to intraday volatility.

This is how many hours of training give-up the ghost into a unmarried hr of trading.  It takes fourth dimension to practice in addition to exam large correlation matrices.  It equally good takes fourth dimension to exam the many other variables that are associated amongst the factors of see in addition to positioning that are primal drivers inwards the electrical flow regime.  Once the inquiry is done, however, the trader knows the indicator levels that are pregnant in addition to is able to automate alerts.  That way, the trader tin terminate seamlessly contain multiple tested technical signals amongst his or her discretionary judgment close the market.

The challenge is non that technical analysis doesn't work.  The work is that technical analysis industrial plant the way that parenting works:  powerful when dynamically adapted to situations; diluted when applied uncritically.
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