Tuesday, August 26, 2008

The Right Tools for the Right Market

As a drywall contractor you don't show up to a drywall job with concrete cutting tools. As a trader we need to be congnizant of what tools we use on what market. And because in trading, as in construction, the tools often define the trader/contractor, it is important that you bid on the right job (i.e. participate in the right market).

A few years ago a fellow trader asked me what I was doing. He saw me using overbought/oversold indicators and other reversion to mean oscillators. And I was trading Forex. He told me "you gotta fit the right tool to the right market". If those were the tools I preferred then I was trading the wrong thing.

Needless to say that conversation prompted me to investigate the emini Futures (S&P 500, Dow, and Russell 2000). These markets respond well to reversion-to-mean indicators. Another lesson I learned is that what timeframe you trade also determines the right tools for the job. When you're scalping the Russell on a 52 tick chart (about 35 s - 1 m depending on the speed of the market) you need to have the 610 tick (about 5 m) chart up to keep you on the right side of the trend. Just cause you are reverting to the mean doesn't mean you want to ignore the big picture.

Today, whether I'm trading futures, forex or something else I know that I need to fit the right tool to the right market.



The Lonely Trader said...

One comment about forex and reversion-to-mean indicators: Being a contrarian trader, you would look at a reversion-to-mean indicator in a way that was fundamentally different than someone who was looking to get into a trend. Just think of all the creative ways in which moving averages can be used...some of them far different than the conventional fashion so criticized by market gurus. Just the concept of "reversion to mean" itself contains within it many perspectives. Lawrence Chan wrote a great blog series on this at the NeoTicker blogs a couple of years ago...wish I could remember the link.

Lord Tedders said...


That's a good point. A good example of this is using bollinger bands as a reversion to mean indicator (it's traditional use I believe) or as a break out indicator.

To me the key isn't so much the indicator but how it's used and taking advantage of the predominant market action for your market and timeframe.


The Lonely Trader said...

Bingo. Well said.