If you understand core concepts you will find understanding the market and techniques used by traders easier. All the indicators and techniques are based on some underlying core concept. Many times the people who promote some of these indicators do not understand the core concept or purposefully package their indicators as something that is anti thesis of a core concept.
For example in recent month many people have been enamored by a particular "mean reversion" strategy promoted by a trader through his book and site and it involves 2 period RSI. I get lot of emails asking how to scan for it in Telechart.
Now this particular person who promotes it makes all kinds of claims like trend following does not work. Or buying strength does not work. He might be right on a particular time frame or a particular time period tested or a particular instrument tested or a particular set up he tested.
But based on that for marketing purpose the person may be making a claim that buying strength does not work. But that is skillful marketing, not a real market understanding. And sometime market will trend for a extended period of time without mean reversion. Which is what it has done in recent months.
Mean reversion kind of systems have had poor performance as per most followers of mean reversion in recent periods. As always is the case the book came out just when mean reversion had become most popular strategy. That is the nature of the market.
Now if you do not understand a core concept like trends or momentum you would accept assertions like only mean reversion works.
But at the heart of the 2rsi is one small trend or momentum filter, it only buys weakness on ETF or Index which is above 200 day MA. So what really is the core concept behind the system. Is it mean reversion or trend following. What the system does is enters a trending market on a minor weakness. The 2RSI entry is meaningless if there is no trend. And by definition there cannot be a mean reversion if there is no trend.
A trend has to be in existent before mean reversion can kick in.
If you understand that logic you can design lot more and better systems by defining a trend and then entering on weakness in trend. Absent that you will believe that there is some holy grail in 2rsi.
Lot of the art in marketing such systems depends on your ability to camouflage a hind leg of a donkey as a thoroughbred horse.
If you are serious about your trading there are some concepts you must know in significant details. Those concepts will help you build a strong foundation on which you can build a trading system. There are seven concepts you should study:
- Momentum : If you understand this you will understand trends and mean reversion. You will understand why and how momentum works in the market. Most indicators are momentum based. Trend following and buying strength also works, so does mean reversion. They are all part of the momentum phenomenon.
- Market Breadth: Stock markets are composite markets. The overall move in market is an aggregate of moves of several hundred or several thousand stocks. So the level of participation in a move is important.
- Equity Selection: Because the overall market is a composite of many individual moves, it becomes critical to select right kind of stocks from the universe of stocks. Hence equity selection is extremely critical. You should know various ways in which one can select equities.
- Market Anomalies: Market anomalies are the distortions in the market. If you base your trading on a proven and statistically significant anomaly, you will be profitable. Absent that no amount of indicators will help you. A through understanding of anomalies will give you an edge.
- Market Microstructure: Market Microstructure is a branch of finance concerned with the details of how exchange occurs in markets. Understanding this will tell you how the market operates. The concept of market microstructre is very critical if you are trading very small time frames or are a day trader. Because to be successful on those time frame you need to find exploitable anomalies in market microstructure. You need to understand role played by market makers, automated programs, arbitragers, large fund buyers and so on. Their tactics and behaviour creates certain patterns
- Growth investing : Growth investors buy stocks of companies growing faster than the average company in the market.
- Value investing : Value investors buy stocks of companies which are cheap or out of favor.
These are the core concepts around which all trading strategies revolve.
Once you understand these core concepts then your next line of study is about trading tactics. Tactics are methods to implement some of these core concepts. Unfortunately most traders start at tactical end. Many blow up their account before they even can understand core concept.
If you want to become a surgeon would you start your study with what scalpel to use or with study of anatomy and physiology.
If your understanding of core concepts is weak or non existent no amount of scans or software's or indicators or trading psychology or multiple monitors or trading chat rooms or advisory services will help you become a successful trader.