Moving Averages
Posted by tktrader on August 17, 2009
Moving Averages
The moving average method of trend analysis relies on the use of various moving averages to identify prevailing price trends. Moving averages smooth the price action by averaging out the noise generated by intraday trading anomalies and small blips in price that are unlikely to have a serious effect on the underlying trends themselves.
MAs ARE TREND FOLLOWING AND THEREFORE ARE LAGGING INDICATORS. EVENTS THAT OCCUR IN CURRENT PRICE ACTION ARE ONLY REFLECTED IN MOVING AVERAGES AFTER THEY HAPPEN. THEY ARE NO CRYSTAL BALL.
When a moving average is moving upwards, the trend is up. When it is moving lower, the trend is down and because noise is filtered out you can be sure that you are looking at a fundamental price movement.
Simple vs. Exponential MA
SMAs are arithmetic averages that average all of the prices over some predefined period of time. They are nearly identical over short periods of time (20 days) to EMAs but react slower than EMAs over longer time periods. EMAs are geometric averages over some predefined period of time and weight recent prices more heavily than distant prices. For this reason, EMAs react faster to recent price action than SMAs do. Traders looking for a simple trend analyzer are served well with the SMA, however, traders looking for the same trend analyzer but with a little faster of a signal are served well using the EMA. Faster signals can however be less reliable as they signal events more often that may turn out to be nothing at all. The EMA argument is that recent price action is more important than past price action. It was in fact this argument that lead to the invention of the EMA. For shorter time periods, 20 – 40 days, there is little difference between and either can be used.
Moving Average Span
The number of prior prices a moving average takes into account significantly changes the number of signals it generates. A slow moving average (ie 200 days) calculates 200 previous trading days worth of price information into the current average and so it is very smooth and calm. A fast moving average (ie 20 days) calculates only 20 previous trading days and thus reacts very strongly to the latest price action in the underlying vehicle. Below are some common MAs
5 day – 5 trading days in a week
20 day – 20 trading days in a month
50 day – common among institutional traders
60 day – 60 trading days in a quarter
200 day – common among institutional traders
250 day – 250 trading days in a year
Periods
5 – 15 days – Very Short Term
16 – 25 days – Short Term
26 – 49 days – Minor Intermediate
50 – 100 days – Intermediate
100 – 200 days – Long Term
Plotting Moving Averages on Charts
Weekly Charts – 10, 20, 39 weeks (50, 100, 200 day equivalents)
Daily Charts – 10, 20, 50, 200 days
60 minute Charts – 65, 130, 325, 650, 1300 (10, 20, 50, 100, 200 day equivalents – x6.5 60′s in 1 day)
15 minute Charts – 130, 260, 520, 1300, 2600, 5200 (5, 10, 20, 50 100, 200 equivalents – x26 15′s in 1 day)
Multiple Moving Averages
Each different time span chosen generates a very different moving average and tells its own story. Shorter moving averages tell the short term trend. Intermediate term moving averages tell the intermediate term and so on. The combination of different moving averages onto the same graph thus shows the different underlying trends simultaneously and how they are moving around each other. If the short, intermediate and long term trend MAs are all sloping up then it is clear that the short, intermediate and long term trends are up and gives a clear indication of the actual underlying trends that exist.
MOVING AVERAGES ARE MOST USEFUL IN STRONGLY TRENDING MARKETS. SIDEWAYS TRADING MARKETS RENDER THEM FAIRLY USELESS IN THE TIME SPAN THAT PRICE ACTION IS CHOPPING IN.
Moving Average Signals
PRICE CROSSES OVER MA. A very common MA signal. Bullish = price action upwards through uptrend MA. Bearish = price action downwards through downtrend MA.
MULTIPLE MA CROSSOVER. When a faster MA crosses over a slower MA it signals that the shorter term trend is changing tide. Bullish = upwards through uptrend MA. Bearish = downwards through downtrend MA. (This signal can lag price action by a huge margin)
ALIGNMENT. Bullish = all MAs stacked top to bottom from fastest to slowest. Bearish = all MAs stacked top to bottom from slowest to fastest.
Charts and Examples of Moving Averages
BMO – 200/50/20 exponential MAs plotted. 20MA and 50MA sit just under price action, clear strong short and intermediate uptrend. 200MA is starting to upturn but notice how long it took before the 200MA finally turned up. The entire early Mar – Aug 6 month rally was nearly in its 3rd month (1/2 way done) before the 200MA rolled over to the upside. Reason – MAs are trailing and follow price action. The huge sell-off to the left of this chart was still being calculated into the MA and pulling it down until enough of the rally was being calculated. Also see that the 20/50/200 are bullishly stacked.
TIM – downtrend clear as day. Bulls died here.
YRI – Gold is consolidating and so along go the gold resource companies and intermediate producers. Choppy price action pulls MAs back and forth with no clear direction. 20/50/200 all moving sideways. Keen eyes will pick out 20/50 trending slightly to the downside signalling short and intermediate trends are down. Long term trend uncertain. Trade with caution…
