Using the Moving Averages
Using the MovingAverages
Although there are
almost countless improvised, and professionally created strategies based on
moving averages, there are three typical methods that lie at the basis of most
of the strategies and methods.
Crossovers arise when
the price rises or falls below the moving average, signaling the end or the
beginning of a new trend. Crossovers are some of the most common occurrences in
technical trading, and as such, do not grant us a great deal of predictive power
in the evaluation of the market action. They are used best in combination with
other tools and techniques when we seek to evaluate the price action with
greater confidence.
Apart from trends in
the price action itself, the moving average can also have its own trend at
times. It is possible to take advantage of these trends for determining
entry/exit points. Although not as reliable as the price trend itself when used
alone, it can be an efficient way to confirm the price action when used in
combination with it.
A divergence occurs
when the trend is in ascendance, but the moving average is descending. A
convergence happens when the market trend is bearish, but the moving average
contradicts it by registering higher highs. These events are thought to signal
a future reversal. When the price action is contradicted by the indicator
values, the expectation is that the market is about to run out of energy, and
it may be a good time to open a counter-trend position. It is important to
remember that timing is very uncertain in all these formations, and that the
anticipated reversal may never occur. Especially in strong trends, it is common
to observe divergence/convergence phenomenon arise regularly without leading to
any significant reversal. Still, it is the rarest, and most popular technical
configuration preferred in the interpretation of a moving average.
We use this term to
define a method of trading in which MAs of different periods are used as
successive resistance levels for the price action to breach. For example, we
expect an ongoing trend to first breach the 1-hour, then the 3-hour, then the
10, and 40-hour moving averages in succession, and may choose to open a
position at each of these successive indicators. Since we anticipate continuity
between levels indicated by these MAs, we will maintain our positions as the
price hops, so to speak, between them.
We'll examine each of
these methods as we discuss each moving average type in its own article. To learn
more about how these calculations are performed you are invited to visit the
relevant page.
The main weakness of
the moving average is its lagged nature. In many cases, and especially for
short term fluctuations, by the time a moving average captures a market event,
it may have already ended. The moving average will only note a developing
market pattern after it has been set up convincingly, and if the pattern is
short-lived, it will not be possible to trade it, and we may suffer from whipsaws
as well.
The strength of this
indicator type is its ease-of-use, clarity, and simplicity. They can be easily
incorporated into any overall strategy, and it is also possible to devise
methods exclusively through the usage of the moving average as well. The great
versatility of this indicator type makes it a valuable addition to any trader's
arsenal of technical tools, regardless of trading style, or the preferred
market type.