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Best vs. Many Technical Indicators: When Error Is Useful

August 25th, 2011 Comments off

Some indicators can provide a better prediction than others so that it seems logically to use the best selected ones to build a composite forecast. On the other hand, even the best indicators can fail. The questions is how to get a consistent good accuracy in predicting – by using only a few best indicators or many good ones. The answer is not obvious and, therefore, a factual comparative analysis would be needed to shed some light on this issue. This short report is based on limited statistical researches; it is an attempt to reach a certain conclusion.

About Expert Method. Apparently, the more good forecasts are taken into consideration, the more precise can be an approximation to actual value. There is Expert Method. This method can be explained by following. As example, an experimentalist shows a pen and asks a group of about 40 people to write down their estimate of the length. Then he collects notes and calculates the average number – normally it is almost 100% accurate. Why it works? Because everyone makes errors in different directions so that averaging gives a precise result.

The Details of Experiment. To find an optimal number of top performing indicators, two tests have been done – using artificial data and real market data. Artificial data allow performing forward testing with more consistent statistics. Although back-testing has been done on out-of-sample sets, it did not have the same forward-testing success every time. Forward testing showed that in average few indicators might produce less accurate prediction than many.

Best vs. Many Technical Indicators: When Error Is Good
The researches and presented chart are made by Technical Analyzer TA-1 (the software is able to compose Neural Network forecasts of many indicators with weights accordingly to each indicator’s predictive ability).

Conclusion. The main conclusion is that relying on a couple of best indicators might yields less consistent success over a long run than using many best and good ones. However, too many is another extreme and not good. The second conclusion is that the list of best indicators is not static – it evolves depending on many factors, including market conditions and, probably, on the number of traders employing particular indicators to make their buy-sell decisions. Thirdly, if the best current top of indicators is known, here is a magic number – it is around 30. And finally, better results are possible if indicators are combined accordingly to their latest back-testing ranking.