To be a successful trader, you must understand markets better than your competitors do. You can analyze them more thoroughly using a computer. Many traders who compete with you in the markets already have these machines.

Manual charting can help you develop an intuitive, physical feel for prices. You can buy some graph paper and plot several stocks or commodity; ties each day. Once you post your charts, write down at what level you will be a buyer or a seller and where you will place your stops.

After you do that for a while, you will probably want to analyze more markets using technical indicators. Then it is time to look for a computer and technical analysis software.

Driving or Walking

A trader without a computer is like a man traveling on a bicycle. His legs grow strong and he sees a lot of scenery, but his progress is slow. When you travel on business and want to get to the point fast, you get a car.

A computer can help you track and analyze more markets in depth. It can take over routine tasks and free up your mind for thinking. A computer

allows you to use more indicators and spot more opportunities in the mar­ kets. Trading is an information game. A computer helps you process more information.

Computerized technical analysis is more objective than classical charting. You can argue about whether a head-and-shoulders pattern is present -but there is never an argument about an indicator's direction. When an indicator points up, it is clearly up, and when it is down, it is clearly down.

Switching from manual charting to computerized analysis is like giving up an abacus for a calculator. It may slow you down for a while, as you learn to push the keys, but the eventual increase in speed is worth the effort.

Three Steps to Computerized Analysis

There are three steps to becoming a computerized trader. First you must choose software, then a computer, and finally data for analysis. Different programs require different computers, which is why it pays to choose soft­ ware first. Software tells a computer how to process data and how to display the results. Each program has a unique list of features and its own look and feel.

Draw a list of tasks you want your computer to perform for you and show it to computerized traders. Contact a traders' group such as Club 3000 to see what its members like. Many traders call Financial Trading Seminars, Inc. for our opinion on the best packages. Magazines for traders, such as Futures and Technical Analysis of Stocks and Commodities carry many ads for tech­ nical analysis software. Read those ads and software reviews, and send away for demo diskettes.

Once you narrow down your choices to two or three programs, call the companies whose software you like and ask for names of users in your area. Insist on names of real users - your best source of practical and unbiased advice. Many traders feel isolated and enjoy contact with other traders. They like to show their equipment and tell you about the quality of technical sup­ port.

Most programs for technical analysis fall into one of three groups: tool­boxes, black boxes, and gray boxes. Toolboxes are for serious traders, black boxes are for people who believe in Santa Claus, and gray boxes are in between. When considering a new package, ask yourself which group it belongs to.

If you want to work with wood or metal, you can go to a hardware store and buy a toolbox with a set of tools. You must learn how to use those tools to work smarter and more efficiently. A technical analysis toolbox provides a set of electronic tools for processing market data.

A toolbox draws daily and weekly charts, splits the screen into several windows, and plots prices and indicators. A good toolbox includes many popular indicators, such as moving averages, channels, MACD, MACD- Histogram, Stochastic, the Relative Strength Index, and a dozen others. It allows you to fine-tune all indicators. For example, it lets you switch from a 5-day to a 9-day Stochastic at the push of a button.

A quality package allows you to write your own indicators into the sys­ tem. You may have a favorite formula that you want to follow, along with ready-made indicators. Avoid programs that limit you to canned indicators.

A good toolbox allows you to compare any two markets and analyze their spreads. If you trade options, your toolbox must include an options valuation model. Advanced packages allow you to test the profitability of trading systems.

There are good toolboxes at all price levels. At the high end, CompuTrac's list of indicators runs to two pages, it allows you to test profitability, and it is highly automated. Most of the charts in this book were drawn using CompuTrac. Financial Trading Seminars, Inc. maintains a list of recommended resources for computerized traders -software packages at all price levels, data services, com­ puter configurations, and so on. This list is updated every few months and offered to traders as a public service. You can receive this timely information by contacting our company at the address that appears in the back of this book.

Black Boxes

Black box software tells you what to buy and sell and when to buy or sell it without telling you why. You put data into a black box, lights blink, gears click, and out comes a piece of paper telling you what to do. Thousands of traders pay good money for this.

Most black boxes are sold by hustlers to gullible or insecure traders. Black boxes always come with impressive track records showing profitable past performance. Every black box self-destructs because markets keep changing. Even systems with built-in optimization do not work because we

do not know what kind of optimization will be needed in the future. There is no substitute for mature judgment in trading. The only way to make money from a black box is to sell one.

Each black box is guaranteed to fail, even if sold by an honest developer. Complex human activities such as trading cannot be automated. Machines can help but not replace humans.

Trading with a black box means using a slice of someone else's intelligence, as it existed at some point in the past. Markets change, and experts change their minds, but a black box keeps churning out its buy and sell signals. Trading with a black box is like having sex using a penile implant - you may deceive your partner for a while, but you will never deceive yourself.

Gray Boxes

Like a black box, a gray box generates trading signals based on a proprietary formula. Unlike a black box, it gives you a general understanding of its for­mula and allows you to fine-tune its operations to some degree. The closer a gray box is to a toolbox, the better it is.

Well-known gray boxes include such programs as MESA . It is considered the best program for identifying market cycles.

Computers

Different software programs run on different machines. This is why it is bet­ter to choose your software before you buy a computer. Get the most modern machine, so that it will remain useful for years. Traders keep demanding more memory and speed - I never heard anyone complain about having too much of either. Buy a fast modem for collecting data from a database. Get a laser printer if you need to print high-quality charts.

Most programs allow you to automate studies and print them out. You push a button and leave the computer alone. When you return, there is a ream of charts with indicators piled in front of the printer. The tedious work is done, and you can go to work making trading decisions.

It pays to hire a person who already uses the package to set up your sys­ tem. I often do that when I start using a new piece of software - it saves a lot of time and energy. Once you know which buttons to push, you can run most programs without knowing much about computers.

Market Data

Each trader needs to start with a historical database and update it daily. In the old days, both had to be created manually. Now historical data for any given market costs less than a dollar per month, and updates are cheap. It takes less than a minute to update a dozen markets by modem, using your regular phone line. There are many reliable databases offering a variety of stock, currency, futures, and options data.

Some traders collect their data around the clock. They use satellite dishes, FM receivers, and dedicated phone lines. Real-time data is necessary for day-trading, but not for position trading.

Position traders enter and exit positions within days or weeks. Day-traders enter and exit trades within a few hours if not minutes. You need to become a competent position trader before you can day-trade. You can compare position trading and day-trading to playing a video game at level one or level nine. You run the same mazes and dodge the same monsters, but the pace of the game is so fast that at level nine your reactions must be almost automatic. If you stop to think, you are dead. Learn to analyze the markets and trade at level one- learn to be a position trader before attempting to day-trade.

When you buy historical data, it pays to cover two bull markets and two bear markets. Starting to analyze a new market, I usually review a monthly chartbook covering 20 years of trading to see whether the market is histori­ cally high or low. I buy three to five years' worth of weekly data and one year of daily data.

When you begin using a computer, focus on six or fewer markets and add more later. For example, you may follow Treasury Bonds, Standard & Poor's 500, gold, and Japanese Yen or the German Mark. Change this list if you want to follow agricultural or industrial markets. Choose a few technical indicators, and run them daily on each market. After you learn them well, add new ones. I use a battery of 10 or 12 indicators at any given time, plus one new indicator. I watch it for several months and compare its signals to others. If it proves useful, I add it to the standard package.

Three Major Groups of Indicators

Indicators can help you identify trends and their turning points. They can provide a deeper insight into the balance of power between bulls and bears. Indicators are more objective than chart patterns.

The trouble with indicators is that they often contradict one another. Some of them work best in trending markets, others in flat markets. Some are good at catching turning points, while others are better at following trends.

Most beginners look for a single indicator-a silver bullet to kill the con­ fusion in the markets. Others lump together many indicators and try to aver­ age their signals. Either way, a careless beginner with a computer is like a teenager with a sports car-an accident waiting to happen. A serious trader needs to know which indicators work best under different conditions. Before you use any indicator, you must understand what it measures and how it works. Only then can you have confidence in its signals.

Professionals divide indicators into three groups: trend-following indicators, oscillators, and miscellaneous. Trend-following indicators work best when markets are moving but give bad and dangerous signals when the markets are flat. Oscillators catch turning points in flat markets but give premature and dangerous signals when the markets begin to trend. Miscellaneous indicators provide special insights into mass psychology. The secret of successful trading is to combine several indicators from different groups so that their negative features cancel each other out while their positive features remain undisturbed. This is the aim of the Triple Screen trading system (see Section 43).

Trend-following indicators include moving averages, MACD (moving average convergence-divergence), MACD-Histogram, the Directional System, On-Balance Volume, Accumulation/Distribution, and others. Trend- following indicators are coincident or lagging indicators - they turn after trends reverse.

Oscillators help identify turning points. They include Stochastic, Rate of Change, Smoothed Rate of Change, Momentum, the Relative Strength Index, Elder-ray, the Force Index, Williams %R, the Commodity Channel Index, and others. Oscillators are leading or coincident indicators and often turn ahead of prices.

Miscellaneous indicators provide insights into the intensity of bullish or bearish market opinion. They include the New High-New Low Index, the Put-Call Ratio, Bullish Consensus, Commitments of Traders, the Advance/Decline Index, the Traders' Index, and so on. They can be leading or coincident indicators.