Timing indicators are divided into three main categories:
• Leading indicators are indicators that tend to give you buy or sell signals before a stock makes its turn.
In a sense they forecast a top or a bottom; however, they do not forecast specific price levels or duration of a move. In theory, there are many supposedly leading indicators; however, in practice there are few that truly lead the markets.
We consider leading indicators to be the most useful for the beginning investor or trader. This is because they allow ample time for you to prepare to make your investment. When applying leading indicators to stocks, remember that your indicator is telling you that a move is going to happen. If you look at your stock charts and expect to see that a move has already begun, you will most likely not see it.
Leading indicators seem to offer the investor the best of all worlds.
However, there are drawbacks when using such indicators. One major problem occurs because it is easy to buy a stock too early. Exposure to price fluctuations that occur before the beginning of the indicated up or down trend may cause you to bail out early. If you are only willing to take a certain amount of risk in a particular investment, and have bought early because you are using a leading indicator, you may be stopped out of your trade, and thus lose all potential for profit.
• Time current indicators tend to turn higher or lower at about the same time that a stock does.
There are many such indicators. They can be very helpful in making long-term investments, and we consider such indicators prac- tically as useful as leading indicators.
The time current indicator should not expose you to as much of the pre-move price fluctuations as the leading indicator does. However, decisions about buying and selling must be made quickly with time current indicators, as the stock should be making its move at the same time that you take your position.
• Lagging indicators are those that lag behind stock movements.
Such indicators are like the tail on a kite; the market moves, and the lagging indicator moves after it. These indicators are also known as trend-following indicatorssince they follow trends and do not attempt to forecast them. Using lagging indicators to make decisions about buying and selling leaves you with a particular disadvantage, because you will be buying and selling after the tops and bottoms of market trends.
Using lagging indicators for the long term is still an effective and acceptable method of investing. If you are positioning yourself for moves that may take a year or a number of years to develop, lagging indicators can help you be confident that you have bought or sold into a real trend. Still, if you are late in taking your position and you enter as the trend is turning in the opposite direction, you may become a victim of the dreaded “whipsaw effect.”
By this we mean you will be buying at tops and getting out at bottoms—clearly a losing strategy. Hence, lagging indicators must be chosen carefully as a function of their characteristics, or they must be used in conjunction with other indicators that will mitigate this inher- ent limitation.
The goal in using a lagging indicator is that the trader or investor will be able to profitably grab a significant portion of a trend before the indicator changes direction again. In strong bull or bear markets, leading indicators do excellent work; however, in sideways markets or markets in transition they tend to lose money and suffer from low accuracy.
Price over Time Equals Timing
While most traders throughout the world use price as the indicator of whether to buy or sell a stock, we believe that the price of a stock is not nearly as important as the timingof your transaction. In other words, we feel that the investor need not be as concerned about the price of a stock as much as the timing of market entry and exit. Timing is the all-important variable.
While many traders and investors are good at discerning the trend of a market, their timing is often poor. Although such people may be able to tell you that a stock will move in a given direction, they themselves oftentimes have a hard time profiting from their knowledge since their market entry and exit are timed incorrectly. They may buy too late or too early or they may sell too late or too early. This is very likely due to a lack of experience in using timing when getting in and out of trades.
Price is important to the long-term investor. However, good timing can overcome the importance of price. Investors and traders alike must move with the existing trend rather than against it. After all, prices that are cheap tend to get cheaper while prices that are expensive tend to become more expensive (both up to a point). Trends tend to continue in their current direction. That is, a stock is more likely to continue moving in one direc- tion (up or down), rather than reverse that movement.
Opinions as to the importance of both price and timing vary markedly.
In reality, an investment and/or trading approach that combines both ele- ments is likely to be more productive and profitable in the long run than a one-sided approach. The coming together of time and price is very impor- tant. The investor who can understand and use both price and time effec- tively is likely to be consistently profitable.
The concept of time and price confluence, when used as a trading sys- tem, is a significant and effective approach for making money. While the concept is valid, putting it into practice is a different issue entirely.
Numerous systems and methods have been developed for the sole purpose of putting this concept into practice.
Someone who buys at support as prices decline in an existing uptrend, is attempting to harness the power of this approach. The same is true when one sells short at resistance. In other words, the investor is attempting to combine price with time by selling at a given price after seeing the market rally or buying at support when a market declines. Being able to discern the trend and the price at which to take a position is a powerful tool that should be mastered, or at least understood, by even the smallest investor.
In order to know exactly when to buy and sell, you will need to be able to define the following variables:
• Trend. What is the current trend? Is the trend up, down, or sideways?
How “strong” is the trend? Is there a way to quantify the trend? What is the “quality” of the trend? Is the market moving sharply higher with considerable rapidity and magnitude or is the trend slow and steady?
• Support.If the trend is up, is there a way to determine where a stock should stop its decline when it goes down (temporarily) during a per- vasive uptrend? Can a specific price be determined and, if so, how?
• Resistance.If the trend is down, is there a way to determine where a stock should stop its rally when it goes up (temporarily) during a per- vasive downtrend? Can a specific price be determined and, if so, how?
The fact is that all three can be ascertained with relative ease. For the time being, suffice it to say that specific methods for doing so will be presented.
Our intent at this juncture is simply to introduce you to the concept. Here, then, are some methods for determining trends and/or entry/exit points. In each case we will explain the method as well as its assets, liabilities, and vari- ations. An example of each technique will be provided in chart form.
There are numerous books on technical analysis that can explain these approaches in considerable detail. The explanations offered herein are nec- essarily cursory and are provided only as a general background to the sys- tems and methods we will discuss in later chapters.