About two years ago I entered a trading slump. I didn’t know what to do to break out of it. When I don’t know what to do I surf the internet. I knew the answer must be out there somewhere. I needed a fresh trading idea. I began hunting around and came upon a chat room that dealt with only one indicator. I was intrigued. Here was a room with several hundred people all focusing their attention on two or three markets, and taking the trading signals generated by this one indicator. And it was free. How good could a free chat room be? Why would anyone put all that effort and work into something for free? It didn’t make any sense. I was even more intrigued.
I clicked a link on the web site and within a few minutes I was listening to the moderator’s voice, saw his charts on the screen, and could read text of comments by the other traders in the room. I had never been in a chat room before.
I heard the voice of a very calm, relaxed man that had just taken 50 or more ticks out of the YM (Dow mini contract). Dozens of traders posted their comments into the room. The posts were of the nature of congratulations for the winning trade, but more so as of congratulating the moderator for such a wonderful, magic indicator, and all the wonderful trading patterns on this magic indicator that were given to all. I observed for an hour or so. I noticed that there were no prices on any of the three charts that were posted. He kept repeating, like a mantra, that you didn’t need prices, the CCI was all you needed.
The magic indicator being used was the old CCI, or Commodity Channel Index developed by Donald Lambert and introduced to the trading community around 1980. I was quite familiar with it, as I had tried using it several times in the past. In fact, I heard the inventor speak at a trading conference shortly after the indicator was introduced into early charting software. But it looked different. It filled the screen, as there were no price bars on the chart. And it had lots of colors that I wasn’t used to seeing. There were histogram bars that changed color with the trend. Very innovative. There were many color changes on the horizontal reference lines as well. Also, instead of displaying just the plus and minus hundred lines along with the actual CCI line, which was the main point to the formula, there were also the 200 lines, and curiously the zero line. Lambert didn’t feel the need to display the zero line, as it was just a simple detrended moving average. But there it was on the chart with red and green dots. The moderator kept referring to the zero line as support. I guess it is, in a way, since a moving average with the proper length can act as support. But I also noticed the parameter was set to 14, which is way to short a cycle to filter out the noise. I always understood that the CCI lookback period should be set to use one full cycle, despite some misleading information on some web sites that I explain in more detail in “CCI – Making it Better,” located in the Indicators section of this blog. So why was a very short 14-bar parameter being used? Nobody in the room questioned the use of such a short parameter. It did give a lot more movement in the CCI line to create the patterns, but I felt they were mostly based on noise, therefore a successful pattern was likely just a random occurrence. But what did I know only being in the room for an hour.
I then posted my opinion about the zero line and the short parameter. No answer on the short parameter, but to the zero line question I got this: “the zero line is not a moving average, it is where the support comes into the market NOW.” He emphasized the word “now” with a touch of irritation in his otherwise calm voice. But what was more interesting, there was a barrage of nasty, venomous comments to me from other traders in the room, chastising me for posting such a dumb comment. After all, this indicator is indeed a magic indicator. Logic doesn’t have to apply. How could I question and degrade it by saying the zero line, which seemed like the most important component, at least in the signals that were being called by the moderator up to that point, was nothing more than a simple moving average. Never mind the fact that a simple moving is in the second line of the CCI formula. I felt like I was the only person in the room that knew this fact.
After listening, quietly this time, for another hour, the moderator made the claim that he invented the use of applying patterns to an indicator. Not only did he make such a claim, but dozens of people typed in praise and thanks. Maybe he just meant he invented using patterns on this particular indicator. He did rename all the patterns, but I recognized a head and shoulders pattern on the indicator, which Martin Pring had written about on the RSI many years before this chat room existed. That bounce off the zero line was a rehash of Raschke’s bounce off the 20 ema and a similar trigger pattern using the 310 oscillator. The failure of the bounce off the zero line, as well as a divergence pattern that had a different name, were all described many years earlier by George Lane and others. I could go on with many more references to patterns on indicators that are well documented in the technical trading literature of many years ago. There was really nothing new here. On the positive side it seemed he did an excellent job of categorizing many different patterns and putting them all together into a package that would be more readily accessible to new traders. So that was good. And there were many good concepts offered on trading in general and money management. And there was wisdom from an experienced person. He would say it would take a person ten years to become a doctor, or some other profession, so why does a trader think he can make a million dollars with two weeks training. That was excellent advice. The chat room was upbeat and positive, as long as I didn’t post any dumb questions of course. I thought I should continue on.
I then thought I had better read the manual, which was in a PDF file on the web site. I learned from the trading manual that the color changes on the horizontal lines were some confirming indicators that had nothing to do with the CCI. One was a red light, green light idea based on a moving average. On the zero line was a red light, green light based on what they called a least squared moving average, which is actually a regression curve. There is no moving average in the formula. But I kept my mouth shut this time, or I should say my fingers. I did start to notice that nobody in the room questioned anything. I asked a few technical questions but most were ignored. When I persisted I sometimes got a private message from somebody that apparently was monitoring the text chat. When I argued with or questioned anything that the moderator said I would get a message telling me to knock it off. This set off some alarms. It partly answered the question why nobody was questioning anything.
Then I noticed that they kept putting up 133 tick charts on certain markets. Most of the time the charts were 3 or 5 minute. I simply asked why they chose that particular number, just out of curiosity. The main moderator said it was a fibonacci number. I knew that wasn’t so. The closest fibonacci number was 144. Not that it makes any difference. I made the mistake of being nit picky again and posted that 133 was not a fibonacci number. I got another private message saying that the next time I questioned the master that I’d be permanently booted from the room. I was never to question anything the master said, and that what he said was correct. In addition to that, a dozen or more posts from other traders said that I was wrong. A couple people came to my defense and said that I was correct. I hope they didn’t get booted. The moderator stuck by his belief that 133 was a fib number.
I know these points are not really important. If the trading methodology is sound I can forgive someone thinking that 133 is a fib number or that a 14 period simple moving average is to be regarded as major support now, or at some other time. But there was one thing being said over and over in the room by most of the moderators and essentially all the participants that bothered me. That is that the CCI is a leading indicator. And it seemed to be universally accepted as the truth. He would show examples where it looks like the CCI gives a trend line break ahead of price breaking a trendline. (He would only temporarily display prices just to illustrate his point.) Now, back to reality for a minute, it is mathematically impossible for a derivative set of calculations to lead the function from which they are derived. Anything said to the contrary is trying to redefine the rules of math. I’m sure what he was trying to say, and illustrate, was that momentum can (at times) lead price. It can in a non-trending market. A pure momentum indicator, such as rate of change, would show this in exactly the same way. Momentum will appear to lead price if the market behaves like a perfect sine wave and you use the correct input into the indicator, which reflects that cycle. Given these conditions a momentum indicator will appear to anticipate the turning points. So at times, somewhat randomly I might add, an indicator will get synched up with the cycle in price and appear to lead. But it is not leading. Nothing leads price. Price is the leader. Every calculation derived from price will lag and follow. Momentum only seems to lead in a cyclical environment where the cycle is in synch with the parameter of the indicator.
And what about trading the CCI with no prices on the chart? To me this seemed like telling someone who’s driving down the freeway at 70 mph to cover up the windshield. Like a voice booming down from the heavens saying you don’t need to see the road, all you need is the GPS. It’s a leading indicator. It is leading where you’re car is trying to go. Why not simply look out the window and drive like a normal person. Why take the very thing you are trading off the screen so you can only see an indicator that is derived from it. The only explanation the moderator offered as to why you don’t need prices is that they’ll scare you out of positions. That might be true, but if you are afraid to drive, covering up the windshield won’t help you conquer your fear. On the other side of the coin, and perhaps a better explanation but one that was never discussed in the room, is that looking at the CCI is actually looking at price. The actual CCI line is nothing more than price as represented by the average of the high, the low, and the close of the current bar. It is then detrended around the same simple moving average as used in the input parameter. Then the resulting price is skewed so that approximately 80% of the price points reside within the plus and minus hundred lines. (There is more explanation on this in the CCI articles in the Indicators section of this blog.) But back to the first side of the coin, by doing this you miss seeing the structure of the market. You can’t get a sense of the size of an impulse move, or the character of a consolidation, or the swing points that are being tested and re-tested, and the resulting success or failures of these tests. You don’t see the market generated information in the pure sense. The CCI is just an indicator. It indicates. Price is the important thing on the chart. A good trader can trade without indicators and only watch price. Everyday in the room the mantra of not needing prices was chanted many times. Every time I would cringe. Each time there would be a flurry of posts thanking the moderator for making them take their prices off the screen. They would claim that their trading had become so much better without looking at prices. I did not dare post my protest.
I had a hard time believing that nearly a thousand people would accept everything that was being said. Accepting it so readily. Were they all drinking Kool-Aid? It was an interesting study on the need to believe in a leader, or a guru. On the need to believe that someone has the answer and to turn over one’s own sense of logic to a stranger just based on what is being said. On the need to keep a dream alive in the face of hard facts.
But I persevered. I felt a calm by narrowing my study to one indicator. And his trading results certainly looked more encouraging than mine. I would get the recaps after market close on days that they were available. Nearly every trade in the recap was profitable. On the rare trade that didn’t work out the loss was usually only a tick or two. I can forgive someone not knowing what a fib number is if I can learn this kind of trading performance. I sometimes didn’t pay close attention during trading hours, so at first I didn’t question the recaps. I was trying to trade my own way and just kept a small bit of my attention on the chat room when these signals were being called in real time. But then I started to pay close attention, as the results in the recap were far better than my results. I tried to write down the trades as they were being called, and then tried to reconcile them in the recap after the market closed. I found that most of the time the trades were hinted at in real time, or if called directly, there would be a hedging comment that could later be referred to if the trade went the other way, so either way the trade was profitable. To be fair, this room was meant to educate traders, not to call out trades. It was OK to discuss a pattern setting up and saying aggressive traders might take this or that trade, or reasons for not taking it. Not every set-up was right for every trader. Some traders might wait for a better signal. If a trade went the wrong way you would be given the option of getting out, or parameters for managing the trade if left on. This was all fine. The point of the live chat was to discuss the patterns and to educate, so discussing the pros and cons of each setup was good. But I began to notice in the recap that the winning trades were selected very carefully out of the real time comments. Nearly every trade called could later be called a winner if you hedged every comment. Again, nobody questioned any of this. There was only a short time from the live commentary to the recap. Was I the only one who noticed the discrepancies?
At this point I decided to do my own testing. I had been in the room long enough to know every pattern, every nuance used by every moderator. I had been to two live events with lectures and real time trading. I was good at TradeStation programming and had the data to test. I programmed everything. Every nuance. Every rule explained in the manual, and every nuances talked about in the room and the live events. I took each pattern individually so I could find which patterns had profitable or encouraging tendencies. I programmed each indicator to use exit rules based on the CCI rules as described in the manual, as well as to just test all different tick amounts for stops and profit targets. Some of the patterns were being verbally touted in the room as having a 90% probability of a successful outcome, and being able to use a two to one or better profit to loss profit factor. I knew this was nearly impossible but those stats were reiterated by many whom were the most respected traders in the room. I had to know for sure if there was anything to the claims.
For my tests I decided I needed thousands of samples over many types of market conditions. I restricted my testing to three of the markets the main moderator focused on. I tested on the two time frames that were mostly used at that time, which were 3 minute and 5 minute bars. I decided to test each of the patterns on five years of data, and broke them up into one year segments. I was just looking for profitable tendencies and robustness. I used bar close for entry. No commissions or slippage were taken out, so I assume perfect fills with no trading costs. I know this is unrealistic, but I was just looking for tendencies. The trading manual said there were three different entries: enter on close, enter last 20 seconds of bar, or enter as pattern appears even if in beginning of bar. The most reliable for programming accuracy was to just test on bar close. I couldn’t program TradeStation to assume a fill 20 seconds before a 5 minute bar painted. I figured if there was a positive tendency using bar close, then in real time I could probably improve my results by entering early, but the test should still show a positive tendency using bar close.
After programming everything into TradeStation I tested the signals by hand, covering several hundred signals on each pattern, just to make sure my programming caught all the signals based on the rules, and didn’t create signals that shouldn’t have been there. I was able to get TradeStation to recognize the CCI patterns with almost perfect accuracy. Even if there were an occasional glitch, I figured with such a large sample size that the results would be accurate enough to know if there were any profitable tendencies using any of these patterns. An early stumbling block was the red, yellow, green light indicator that allowed or disallowed the signal with the bounce off the zero line. That was proprietary. The indicator was available, but not the code so I was unable to put the code into my strategies. I figured out the formula by trial and error, so now had all the tools to test.
After spending weeks and reams of paper for my printouts, I found that none of the patterns resulted in a profit in any of the previous five years when tested mechanically. The high percentage trade I referred to earlier actually lost money, and had closer to 30% winning trades, about a third of what was being verbally touted. I’m sure the true believers would doubt my programming. Maybe there were some rules I missed. If so they weren’t posted on the web site or talked about in the chat room. The bounces off the zero line fared slightly better, but still far less than 50%, some years closer to 30%. Results less reliable than the flip of a coin. The two divergence patterns were the lowest percentage of winners. Some of these patterns I could get to show around 60% winners if I removed the stop loss, and then set the profit objective very close, something like 3 or 5 ticks. But of course that lost a lot of money, and that was without calculating commission and slippage costs.
To summarize my testing: nothing worked. Nothing came close to a favorable tendency.
I tried to tell other people in the room about my research and the dismal results. Most of them wouldn’t hear it. They didn’t want to hear the truth. They were too invested in the method, and they had to believe they would eventually become successful if only they would hang on a bit longer, attend one more live event, just learn that secret that’s just around the corner.
I did notice some defection in the room, as there was another trader who seemed to have a better approach. He was gaining a following, which was no surprise if my dismal testing results were indicative of other traders account balances. I then programmed his new system into TradeStation and tested it. It was based on some sound theories, namely extending the CCI parameter on one of the components to something more realistic than 14, although he did keep the 14 parameter in part of the equation. But my mechanical testing still did not result in a positive return. It was better, but still a loser, at least trading it mechanically. Maybe he was successful using it as a guide to his discretionary trading, but programmed as presented it was a loser, despite the hype. He was eventually booted from the room. Although the results of the testing did not result in anything useable, it encouraged me to do further research, which lead me to using a much longer CCI parameter, and eventually an adaptive parameter, and to adjust my rules based on the different character of using such a parameter. (I have more on this topic in the Indicators section of this blog.)
Testing any system mechanically will most likely result in a negative outcome. I do not believe that a system has ever existed, or that ever will exist, that you can program into a computer that will trade a market profitably over the long run. There might be some arbitrage system that can work, but as far as calling market direction with a net position, I just don’t think there is such a system. So, I didn’t expect to find a system I could trade mechanically and automatically. If such an approach were possible someone would have it, they would be at the golf course all day, and they would come home and count their profits. Eventually they would probably own the world. But if a system has a chance of being a reasonable guide to a discretionary trader, which is what I think is the best someone can hope for, it should at least show results better than a coin flip.
You might assume my time spend in this room a dead end or waste of time. That maybe I thought that this guru did have the answer to trading success. I knew better than to expect this. The sad part is that so many other people don’t know better. They are told something that they want desperately to believe, and they believe it. They don’t test it. They don’t question it. They believe blindly. They invest much time and money, and then they get past the point where they simply want to believe. Now they are too invested and they have to believe. They will disregard all common sense and all facts and proof in an effort to keep the dream alive.
Trading is hard work, and every trader has to find what fits his or her own personality and temperament. Nobody is going to easily give it away, whether in a free chat room, or a paid room or seminar, or a so-called trading school. There’s a whole industry out there that supply traders with tools and education. Much of it is good. Most of it is a waste, taught and promoted by people who are not successful using the approach themselves. Ultimately, one has to do one’s own work. And everything should be questioned. Everything should be tested. Every indicator formula should be understood. There are only so many ways one can apply math to the few prices represented on each bar of a chart. There is no magic indicator.
My experience through all of this did result in some good. I don’t regret a minute of the time I spent in this chat room. I met many people locally at meetings. I felt a sense of belonging to a community of traders in an otherwise solitary pursuit. Being in the room and questioning everything helped encourage research. I focused on one indicator longer than I ever had in the past, which resulted in developing trading rules on patterns that I would have probably overlooked. And the patterns in the chat room, even though weren’t original or profitable as presented, did become more useable to me once I changed the indicator and adapted them to my trading style. I think most of the patterns were based on sound theories. Certain nuances start to pop out when you see that same thing appear over and over. You miss these if you try to view too many indicators. Before being in the room I viewed too many indicators and spent much more time frozen in indecision. So I did learn some things by being in the chat room. I have tried other chat rooms briefly and in comparison I think this room is probably one of the better rooms to be in, as long as you think for yourself, do your own testing, and you are not looking for a guru to follow. I also learned about psychology and the mind of the traders that I compete with every day.