Trading with basic moving averages

Nov 22 • Between the lines • 3652 Views • 4 Comments on Trading with basic moving averages

jumping-ropeRecently we covered the use of the most widely held indicators and how adjusting them and using them in a counter intuitive way to their accepted use, can provide a very simple ‘one indicator’ method to enter and perhaps more importantly exit the market.

We illustrated how to adjust the settings on indicators such as the RSI and the stochastics in order to implement a completely different method when looking to enter and exit. For example; we altered the RSI to a 5 day period on the daily chart as opposed to the 14 day period and entered the trades when price breached the 70 and 30 overbought and oversold areas. Then we exited when price pushed back through these key levels in the opposite direction, as sentiment shifted.

Indicator based trading attracts a lot of criticism on trading forums and on various blogs, and that criticism is often unwarranted. The expert analysts and mathematicians who invented indicators such as the: MACD, DMI, RSI and stochastics should be respected for their breakthroughs, not dismissed. Very little has changed in trading where technical analysis is concerned over the past fifty years or so, therefore indicator based trading methods are as valid now as they were back then.

One of the reasons indicator based trading is so casually dismissed is that it looks and feels too easy; “we’re on the daily chart the MACD turns positive, as does the DMI, PSAR has just gone below price, whilst the RSI has breached the 50 median line, therefore it’s time to take the trade” just doesn’t offer up the levels of complication that many fledgling traders are searching and hoping for. They’re seduced by peer opinions and believe they’re on a quest to discover a secret trading formula. In fact the best we can really achieve, on any given time frame, is to follow price and using indicators on, for example, a daily chart is often as good as it gets.

Many new traders, after experimented with indicators, tend to move onto other trading methods, perhaps using Fibonacci retracement tools, believing that such indicators offer up greater trading opportunities as price often reverts back to its mean reading. And without a doubt Fibonacci trading methods can reap rewards in the right experts’ hands. But there’s also another much maligned method of trading that many new traders may stumble upon to then dismiss fairly quickly, using moving averages…

Making trading decisions using moving averages also belongs in the stable of; “surely it can’t be that simple?” view of trading methods. Simply waiting for two abstract lines drawn on a trading chart to cross, or for price to push through a line on a chart looks like child’s play to many, consequently it’s dismissed as being too obvious. The reality is that certain moving averages, particularly the 200 simple moving average, the 100, the 50 and the 20 day moving average are key lines that many experienced traders will make judgments on and from.

 

What does a moving average cross over actually reveal?

It may come as a surprise to many fledgling traders that many very successful traders have used nothing more than moving averages on their charts and what’s more they use the moving averages in the most basic ways…

Some traders use the larger MAs such as 50, 100, 200 as ‘lines in the sand’ that if breached will indicate strong momentum. Some traders use the moving averages as rejection points, they’ll predict that price will reject these levels as they often correctly predict that many institutional orders will be present at these levels causing price to fall as many orders are filled.

We have to take on board what we’re witnessing when two moving averages actually cross. If the 20 day moving average crosses the 50 day we’re witnessing price diverge from the established mean. We’re witnessing a divergence from the mean, we’re witnessing a reaction. It must also be noted that many of the preferred indicators we may have faith in, such as the MACD and Bollinger bands are quite simply clusters of moving averages.

So how can we use moving averages? Well we’ve provided a few suggestions already, cross overs, rejections, price simply crossing a moving average line such as the 20/21 day on a daily time frame. If there’s any other simple uses of moving averages that our readers have perfected we’ll be delighted to hear from you, please leave any comments at the footer of the article.

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