What is the Best Trading Indicator?
No matter what you are after in life, you always want to make sure you have the best of everything.
When it comes time to trading, beginners look for the absolute best trading indicator on the planet.
The truth is that there is no one best indicator, and that it is very subjective because it differs for the type of trader you are, the product, and heck it can even change with the seasonality. Read more about stock market seasonality here.
The best trading indicator for me would be the one I CANNOT trade without.
That indicator is correlation.
It is very fitting that this is my favorite and the best trading indicator, because it is the one that a beginner is least likely to use.
Why Correlation is the Best Trading Indicator
New traders forget that stock markets are nothing more than a vast pool of capital looking for an investment that will earn a superior return.
The truth is that while new money comes into the market and leaves, the majority of volume and traders are merely re-positioning existing money into a different mix of the same securities.
Why is this important?
Because as existing money gets shuffled across different assets, it creates predictable movements that can be tracked by following inter-market relationships and correlation.
No other indicator, system, or holy grail promise can come close to generating the profits that market correlation can.
The Best Trading Indicator – The Classic Correlation
One of the most stable and consistent correlations to follow is the relationship between stocks and bonds.
Because these two markets are the staples and core of most portfolios, they are moving in opposite directions.
Take a balanced fund for example, which typically has 50% invested in stocks and 50% in equities. (hence the name, balanced).
What happens when stocks rally?
The funds sell the right amount of stock and use that money to buy bonds in order to restore the initial 50/50 balance.
This in turn leads to stocks dropping as institutional money managers sell them, while bonds increase at the same time (and vice versa).
So you need to start following bonds right away by adding them as an overlay on your charts.
Watch the 10 year notes and 30 year United States bond futures and compare them to the price action of equities, and you will be amazed at what you find.
Heck, I will actually do the homework for you.
Below is a chart comparing the SP500 to the USA 30Y TBond Futures (ZB). This is a weekly chart, starting a few months before the big housing bubble collapse:
The Best Trading Indicator : What are the Best Market Relationships to Follow?
This is where it gets slightly more complicated, and interesting.
You need to use different correlations and markets depending on what kind of trading you are doing.
There are correlations for currency, futures, options and more. In fact, there are even specific correlations for each separate product or market you trade.
If you are a swing trader or day trader, you can change the time period of the charts you are using. Daily charts are a good starting point, and you can also use 4H charts at the same time.
Day traders can ride correlations for a few minutes to hours, while swing traders can ride trends lasting a few days to multiple months.
If you would like to discuss what could be a good correlation setup for you, feel free to contact us and we would be happy to help.
Additionally, the Futures Course is included in the Day Trader PRO and Bundle packages. The course goes into full detail on how to find correlation, apply it to your strategy and maximize your profits.
The Best Trading Indicator : How to Read a Correlations Matrix
One way to find out which markets are correlated is to look at a matrix.
Here is an example of a correlation chart snippet from MRCI’s Inter-Market Correlation Charts. Visit this link and get the full charts here.
As you can see below, the ES futures contract (SP500 equity futures) are highly correlated to NQ, which is the Nasdaq.
Anything above 90 is a very strong positive correlation, and they are expected to move together.
The ES on the other hand is inversely correlated to the Eurodollars (EDU). The ratio is -85.
This means that if the ES is going up you can expect to see the Eurodollar drop. If it is not, the trade is suspect and should be up for further review and analysis.
One thing to remember is that correlations change constantly, and you must observe the relationship on a continuous basis.
Some markets are strongly correlated for a long period of time and won’t change much. Other markets will change day to day and even minute to minute.
The Best Trading Indicator : Conclusion
I know you were wishing that you would find some super easy to use indicator, that would flash a blue arrow when to buy and red arrow when to sell.
You would follow those arrows to millions and never work a day in your life again.
You did not get that type of indicator, but you did get the best trading indicator in the world.
Correlations are used to get you into trades and get you out of them.
They are also used to keep you from selling out of a position, or from entering one.
They are so versatile and powerful, making them hands down the best trading indicator.
Look across institutional and professional trading desks and you will find them all using this same indicator. Now you have the same tools.
Good luck and good trading.
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The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.