This is Part 2 of an interview with Raymond Rondeau, new CI contributing editor, who will be writing a series on Classic Technical Indicators. In Part 1 of the interview, which ran in the April edition of CI, Ray discussed the many potential negatives and pitfalls of working with indicators and technical analysis in general. This second part of the interview covers the benefits of working with technical indicators. These interviews serve as a good introduction to Ray’s new Technically Speaking series, which will debut in the June issue of CI.

Jackie: Up to this point (in Part I of this interview), we have covered a number of the potential pitfalls and cautions with indicators. Let’s turn to the benefits.

Raymond: Earlier, we talked about some of the long-term influences of price movements. The good news is that technical indicators can influence price movements, at least to some degree, in the short term. This phenomena is more pronounced during quieter or less volatile times, when there is nothing else influencing pricing. The truth is that specific price patterns and indicator signals often have a self-fulfilling nature to them. The more people and programmed computers that follow the signals, the more relevant the technical patterns and signals become—“What people believe often prevails over truth.”

As experienced technicians will attest, we often see prices react at key indicator points, such as a 200-period moving average (MA), simply because of the widespread belief that the 200-period moving average is relevant. [A moving average is a lagging indicator calculated by averaging the closing prices of a stock for a given period.] Because of this, it can give an observer a small element of predictability into the likely future price movement’s direction and magnitude. Additionally, because technicals show specific strategic price areas on a chart, we can often make further future price action evaluations at these points by comparing what should or shouldn’t happen according to the rules of technical analysis.

Jackie: If I understand you correctly, technical indicators can assist an investor with execution?

Raymond: Absolutely. This type of analysis can help an investor formulate higher probable entry and, more importantly, exit areas based on the technical landscape of the charts. This is based on the logic that the entire market is looking at the same exact formations and anticipating the same exact outcomes, at least from a technical perspective. Because of this, it gives the technical investor numerous potential advantages.

First, execution prices are no longer arbitrarily chosen based on where your breakeven point is or how much money you would like to make. With this approach, execution areas are now selected and based on the theoretical higher-probability areas of the charts that everyone is looking at and considering.

Secondly, if we base our investment decisions on something that is concrete and tangible (from the charts), this helps us be more objective. This is one of the biggest benefits of using charts and indicators. By incorporating a technical approach, an investor reduces the uncertainty and the related emotional intensity of having money at risk in the markets. This can keep an investor from reacting emotionally to fear and greed impulses, and it can help them remain in wise-mind. Emotions are something that most experienced investors would agree are the bane of their existence, and one of the more detrimental influences to their overall returns.

Jackie: In addition to assisting with price forecasting, locating entry and exit points and reducing the emotional component of investing, are any other benefits to working directly with indicators?

Raymond: I think that one area clearly underutilized by many investors is using indicators as a scanning tool. Most people tend to use indicators to analyze a specific stock that they already have a positon in or are interested in acquiring. Fewer people use indicators to effectively locate potential stock candidates.

For example, let’s say an investor wanted to increase their exposure in the energy sector because they thought that it was extremely oversold. They could easily scan for energy stocks using various indicator values. For instance, they could scan for stocks that have a relative strength index (RSI) value under 30, but that is now rising and showing strong relative strength to the other issues in its sector. [Relative strength is a momentum indicator that measures the magnitude of price movement in a security.]

Indicator-based scanning tools are easily found, simple to contour and implement and are available free on the web and in most brokerage platforms. In fact numerous websites have a number of free technical scans already set up for you. With these scans, all you have to do is click a button to populate the list of candidates meeting the defined criteria. Even better, many platforms and websites now let you combine both fundamental and technicals into one unified screening criteria. [The Technical Analysis section of CI’s Best of the Web lists which sites offer technical screening.]

Jaclyn: Are there any other areas where you feel that indicators are underutilized or where they can be used more effectively?

Raymond: One area that sometimes seems overlooked in regard to using indicators is that of alternate interpretations. What I am referring to here are techniques that differ from the more basic commonly publicized methodologies. As I said in the first part of this interview, these alternate methods do not have to be more complicated.

For example: Extreme level moving average convergence/divergence (MACD) crosses are an easily recognizable and a relatively good signal. But MACD divergences are really not that much harder to spot on a chart, and some would argue that they are even more relevant. Therefore, my Classic Technical Indicator series covers a variety of different interpretations and approaches for each indicator.

Jackie:Which technical indicators you are planning to focus on in your series?

Raymond: I will probably go with many of the familiar names: moving averages, relative strength index, moving average convergence/divergence, ADX (average directional index), stochastics, and Bollinger bands to start. I want to make sure that we hit on all the major indicator types: leading, lagging, momentum, volatility-based indicators, etc.

Also, within each article I plan to list “like or similar” indicators to the primary indicator being covered. Included here will be some comparative return statistics on these similar indicators. It should be interesting to compare which of these indicators have performed best in the past and how they have performed in relationship to the primary indicator being covered.

Of course, my list of indicators to be covered is always open for suggestions. If readers have a particular interest on a specific indicator that they want covered, they can send their suggestions to CI@aaii.com or comment at the bottom of one of the articles.

My objective is to provide an unbiased look at both the strengths and weaknesses of each indicator, and to do so without my own personal agenda or biases. My goal is not necessarily to influence as much as to provide information and share some general guidance from my experiences as a trader/investor. Again, there are no best indicators for everyone and all situations.

Jackie: Do you have any final thoughts or advice that you want to share with those who are new to the study of technical indicators?

Raymond: As with most things in technical analysis, there are pros and cons. If one keeps a good perspective of what indicators can and can’t do, they should be fine. My advice would be to research, choose wisely and then focus on a good strategic combination of just a few indicators. Each investor should target indicators that they truly understand and are comfortable using, as opposed to picking the indicators that appear the most complex or that are the newest “flavor of the month.” Be patient and you will soon get an inherent feel for the indicators and how you like to interpret them so that they work best for you.

Lastly, always keep learning. This is where AAII, Computerized Investing and this Classic Technical Indicator series will truly assist. If you remain diligent and persistent, there is absolutely no reason that you too shouldn’t be reaping the many benefits of using indicators.

Jackie: Thanks. Ray! I am certainly looking forward to the release of this series.

Raymond: Thank you, Jaclyn!

Editor’s note: The first article in the series Classic Technical Indicators, on the relative strength index (RSI), is scheduled for release in Computerized Investing’s June edition.