A trading signal is not an outcome
Can a trading indicator predict what happens next?
I want to challenge something almost every trader takes for granted. No trading indicator on this planet knows whether its next buy or sell signal is going to be right. Not one.
Before you disagree, think about that for a moment. We spend enormous amounts of time looking for indicators that tell us when to buy and when to sell. We compare them. We backtest them. We ask about their winning percentages: is it 60%, 70%, perhaps even 90%? But there’s a fundamental question we tend to overlook. What exactly are we measuring?
At the precise moment an indicator tells you to buy or sell, something very important hasn’t happened yet: the market hasn’t responded. Whether it moves in your favour or against you depends on what buyers and sellers actually do after the signal appears.
So here’s the question I’d like you to keep in mind. What if we’ve been asking trading indicators to answer a question they simply cannot answer? And what if understanding that could make trading considerably simpler?
Why do trading signals fail?
Imagine you’re looking at a chart and an indicator suddenly produces a green arrow telling you to buy. Why has that arrow appeared?
Somewhere inside the indicator, a set of conditions has been satisfied. Perhaps two moving averages have crossed. Perhaps momentum has increased. Perhaps several different calculations have aligned. Whatever the method, those conditions have occurred and the software has recognised them. So far, so good.
But everything that caused that arrow to appear has already happened. The indicator has recognised a particular set of circumstances. What it hasn’t done is establish what market participants are going to do next. Will buyers now start buying? Will sellers start selling? Will the move continue, or reverse? The indicator doesn’t know. It only knows what has already happened.
It may identify conditions that have historically been associated with a particular outcome, and that can be useful. But the next outcome is not yet known. So when a signal “fails”, the indicator has usually done exactly what it was built to do: it recognised its conditions. What it could never know was how buyers and sellers would respond.
What does an indicator’s win rate actually measure?
One of the first questions people ask about a trading indicator is, “What’s its win rate?” I understand that. You’re going to risk money, and you want some idea of how reliable something is. But it’s worth examining what a winning percentage actually represents.
Suppose someone tells you their indicator has a 75% win rate. That sounds impressive, but 75% of what? Where did they enter? Where was the stop? When did they exit? How long did they hold the position? Every one of those decisions influences whether a trade is eventually recorded as a winner or a loser. You can take exactly the same indicator, change the trading rules, and produce a completely different result.
That doesn’t make backtesting worthless. Backtesting can be useful for understanding how a properly defined strategy performed in the past. But that is the point: you’re testing the complete strategy, including what happened after each signal appeared. A winning percentage cannot tell you how the market will respond to the next signal, the one that hasn’t appeared yet. That is still unknown.
Yet it’s remarkable how easily a historical statistic turns into a feeling of certainty. We see a buy signal, remember the impressive win rate, and suddenly feel that the market ought to go up. But the market doesn’t know anything about our indicator, and it certainly doesn’t owe us the outcome we’re expecting.
So perhaps there’s a more useful question than “How often does this indicator get it right?” Perhaps we should be asking, “What is the market actually doing after the event that produced the signal?”
What is price acceptance and rejection?
Every time the market attempts to move towards a new price level, something has to happen for that movement to become established.
Take an upward movement. Price suddenly pushes higher. The market has moved towards a higher price, but will that higher price be accepted? That’s the question. For the move to become established, there must be sufficient willingness among market participants to continue trading at those higher levels. Whatever the precise balance of buying, selling and available liquidity, the market has to establish itself at the new level.
There’s another possibility. Those higher prices may attract more selling, or the buying interest responsible for the initial movement may simply disappear. Then the market can fall straight back to where it came from.
So the same initial event has two possible outcomes: acceptance or rejection of the higher prices. Exactly the same principle applies when the market attempts to move lower. Will those lower prices become established, or will they be rejected?
The push is only an attempt
Here’s the really important part. The initial push doesn’t establish which outcome will follow. It’s an attempt, and we need to watch what develops afterwards.
Picture the market moving upwards. At that moment there appears to be a strong upward movement. But then the market doesn’t establish itself at those higher prices. Instead, it returns towards the area it came from. The upward movement certainly occurred, but the attempt to establish higher prices failed.
That’s the distinction I want you to recognise. The push is the attempt. What follows tells us whether the attempt is succeeding.
How PAT helps you observe developing market behaviour
This is where a different type of indicator comes in. PAT stands for Professional Activity Tracker. I developed it around a method I was trading more than two decades ago, which I called the Market Maker Method. It was first published in Futures and Options World magazine in December 1999, back in the days when you had to physically call a broker to place an order.
The idea behind it is very simple. Rather than asking an indicator to predict what happens next, I want to identify important market activity and then observe how the market responds to that activity.
On a PAT chart you’ll see three important features. If you can understand these three things, you can read a PAT chart. Each draws attention to a different aspect of developing market behaviour:
- The Purple Dot tells you that an unusual concentration of activity has occurred. It’s worth paying attention to.
- The Ray Line provides an important reference. The principle to remember is strength above the Ray Line and weakness below.
- Pressure Points, the yellow points on the chart, identify an attempt to push the market towards a new price level. An upward Pressure Point identifies an upward push; a downward Pressure Point identifies a downward push.
Neither kind of Pressure Point tells you that the attempt is guaranteed to succeed, and neither tells you that you must immediately enter a trade. Instead, it gives you something meaningful to investigate: is this attempted push being accepted or rejected?
Reading a Pressure Point instead of following an arrow
Suppose a Pressure Point shows an upward push. Rather than automatically buying because a yellow arrow has appeared, I want to see what happens afterwards. Does price continue to establish itself above the point, or above the Ray Line? Does it move with conviction? Or does it hesitate, fall back and begin to show rejection?
Notice how different that is from simply following the arrow. We’re not trying to predict an outcome from a single moment. We’re reading the behaviour that develops around that moment. That is really the purpose of PAT.
Reasons to consider a trade, and reasons to reconsider
Most trading education spends an enormous amount of time teaching people when to enter a trade. Look for this setup, wait for that signal, and when everything lines up, enter the market.
But what happens after you’ve entered? This is where trading becomes interesting. The moment you have money on the line, your thinking can change, and often does. You entered because you expected something to happen. Now you want it to happen, and it becomes very easy to start defending that original decision. Yet the market is still developing, and the reasons that persuaded you to enter may not remain valid.
So I prefer to think about trading in two stages: reasons to consider a trade, and reasons to reconsider it. The first is about recognising circumstances that might justify taking a position. The second is about continually assessing whether those circumstances still exist. I believe the second is every bit as important as the first.
Imagine a market developing strength above a Ray Line. We see activity that gives us reasons to consider a long position, and we decide to enter. The decision-making doesn’t stop there. Is the market maintaining its strength? Is the upward movement still being accepted? Or are we beginning to see a change? Perhaps the market starts moving back towards the Ray Line. Perhaps it loses the ability to establish itself above it. Perhaps the reasons we had for entering are beginning to disappear. Now we have reasons to reconsider.
Notice that we don’t have to know exactly where the top of the move will be, or predict the next ten candles. We’re simply responding to information as it becomes available. We still need sensible risk management, and reading the market doesn’t remove risk or guarantee we’ll make the right decision. But it gives us a different way of thinking. Instead of being committed to a prediction, we stay committed to observing what the market actually does.
Three better questions than “Is this a buy signal?”
An indicator can recognise important conditions. It can draw our attention to unusual activity. It can identify an attempt to move the market towards a new level. But it cannot know with certainty whether that attempted movement will be accepted or rejected. That part of the story hasn’t happened yet. So I think we need to change the questions we ask:
- Instead of “Is this a buy signal?”, ask “What is the market attempting to do?”
- Instead of “Is the indicator right?”, ask “Is that attempt being accepted or rejected?”
- Instead of waiting for a perfect signal to tell you when to get out, ask “Do the reasons I entered still exist?”
When you begin thinking this way, something rather interesting happens. You stop looking at the chart as a collection of separate indicators, and begin to see a developing sequence of events: an attempt, a response, acceptance or rejection, and sometimes a change in direction. That’s what I designed PAT to help us observe. Not certainty, and not predictions, but a better understanding of the market as it develops.
Learning to read the market, not predict it
An indicator tells you something has happened. The market tells you whether it matters.
Once you understand that distinction, you may find you’ve been making trading far more complicated than it needs to be. Perhaps the real skill isn’t learning how to predict the market. Perhaps it’s learning how to read it.
