Multicollinearity

A horrible unreadable chart
Too Many Indicators, an unreadable chart

The most important thing to know about technical indicators is that what you are seeing is in the past.  So, it doesn’t matter if you use a Moving Average or MACD, it’s all in the past.  Also, MACD is a calculation based on Moving Averages so if you have both, you are cluttering your charts with two views of the same thing.  This is Multicollinearity, if your indicators are based on closing prices, you only need one of them.

Mean Regression is the justification for trading Moving Averages, the price reverts to the mean (average).  However, you just have to try it, or look at a chart to see that just as often the Average will catch up to the price.

Unlike natural phenomena, say an athletes performance, price is not bound to revert to the mean because the underlying factors that determine performance aren’t limited. If the ECB launches a new QE program then today’s Euro won’t be worth as much as yesterday’s Euro, there is no point sitting there waiting for it to revert to the mean. Price Discovery kicks in, and that’s one very important element that does not have a Technical Indicator.  In such a scenario, Technical Analysis will have to be suspended until the price settles into a new Trading Range.

Athletes performance? Yes, the Sports Illustrated effect. When an athlete in a rich vein of form makes it to the cover of Sports Illustrated, his performance drops. Aka, the Curse of Sports Illustrated. In this scenario, the athlete is actually performing above his mean for a period and gets noticed. So they put his picture on the front cover. Then, his performance reverts to the mean, and Sports Illustrated gets the blame. The reality is nothing happened, performance is variable in any sport. Each athlete has certain average or mean where he performs most of the time, occasionally raising his game, sometimes dipping below.

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