Tuesday, 8 November 2011

Making Use of Cycle Indicators (Part 1?): TMA and Kelly's Cycle Identifier

Most cycle identifiers repaint, and the ones that don't are often not useful. I've hear from a veriety of forums that most of the authors of these cycle identifiers have given up on the idea of ever finding the non-repainting cycle identifying indicator. I am certainly with those authors, since I do not believe we'll ever find the perfect cycle identifier. I've done the searches for them, and I always come up empty handed.

There is, however, the repainting indicators that remain from all that searching. But what could you do with indicators that change their mind? Well, you use them for everything BUT entry points.

I believe that cycle identifiers are the best at two things:
  1. Determining the prevailing direction of the price action, and
  2. Exit points
A number of my indicators are early-indicators and tend to have a lot of false signals, but with the cycle identifier I can filter half of the signals by predicting the direction of the price action. You do, however, need to have a cycle identifier that does not repaint past the typical point that your early-indicator would show as an entry point.

The best one I've found so far is a TMA indicator I found in the Elite section of Forex-TSD. This seems to work quite well with a NonLag Moving Average Histogram I also picked up in Forex-TSD (not sure if I found that one in the elite section or the public section):

The TMA does repaint like most cycle identifiers do, but if I use the NonLag Histogram (which does not repaint) as my entry point when the colour changes, I can then use TMA as a filter for the false signals produce from the NonLag Histogram, and indicate where my next top or bottom will appear. I haven't made any money from this setup yet (still playing with the settings), but I do believe that this goose will produce some golden eggs.

As I also mentioned, you can also use these cycle identifiers as exit points. Cycle identifiers are great exit strategies since they try to predict the top/bottom, and if the cycle identifier fails to find the top/bottom, then you still would end up with profit. The one problem with this is that you need a cycle identifier that does not repaint frequently. One of the better ones is Kelly's Cycle Identifier. This indicator is not too quick to draw out a top or bottom (given the right settings), and keep you in the game a little longer than a trailing stop or a take profit. The problem with this setup is that you have to watch the chart constantly in order to catch that possible top/bottom before it reverses. 

I hate to say this because everyone says it, but these systems do not work every time. You find unique circumstances where you will be left with a loss. This might occur when your spread is too large, and your predicted price action can't penetrate it; or the early indicator gives a false signal; or the cycle identifier marks a position at the same time the early indicator says, "Hey, come on in man", but the cycle identifier soon changes its mind and your left a loss... and so on.
So, keep in mind Money Management, and stop-loss strategies to prevent too much loss.