Sunday, 18 December 2011

Moving averages as a trend indicator

I usually open trades in response to edges from trend lines and chart patterns. I exit trades for all manner of reasons, more often money management than due to anything on the charts, but that's another topic.

The drawing of trend lines and chart patterns is a subjective thing, at best an art, and certainly not a science. I reckon I have a pretty good eye for drawing lines on charts, but I like to pass these subjective edges through a objective filter. To do this, I keep an eye on what my simple moving average system is saying.

I place three simple moving averages on my charts. A 4 period, 18 period, and 40 period.

How do I interpret them? Simple... there's three options.

Up trend: If the 4 is above the 18, and the 18 is above the 40.

Down trend: If the 4 is below the 18, and the 18 is below the 40.

No trend: Anything else.

If there is a trend on the weekly chart, that's a signal to look at the daily chart for edges in the direction of that trend.

If there is a trend on the daily chart, that's a signal to look at the 4 hour and 1 hour charts for edges in the direction of that trend .

If there is a bullish or bearish cross by the 4, 18, and 40 period moving averages all at the same point on the chart, then I am watchful for an especially strong subsequent move, which doesn't always end up being in the direction suggested by the moving average cross.

In addition to checking the moving averages, I keep my eye on MACDH as a momentum indicator. Momentum divergences are a powerful signal, especially on the weekly chart.

If your gut is screaming "strong trend, let's leverage up" you shouldn't believe it unless the trend is clear according to the moving averages, and momentum is negative in a down trend, or positive in an up trend.

The posts from earlier today provide illustrations for the above definitions. As a variation on my usual published chart style, I have removed all trend lines, and I have shown MACDH. It's a pre-Christmas sanity check for myself, to review whether what my lines and gut are telling me actually holds true when measured objectively.

Note to self: having barely scratched the surface of the use of moving averages and MACDH, I should write some more in future posts. Charts to illustrate each point would help!

h/t to my two favourite moving averages references.... Many of the 100s of trading books that I have read describe the use of moving averages. It is difficult to remember which books I stole my ideas from, as the same ideas appear in many different books. To my mind, the two best treatments of moving averages are the following publications:

The Magic Of Moving Averages by Scott Lowry

How To Trade The Highest Probability Opportunities: Moving Averages by Jeffrey Kennedy

S&P 500 moving average trends

No trend on the weekly chart. Momentum is positive but showing a bearish divergence.


No trend on the daily chart. Momentum is negative.

ASX 200 moving average trends

Trend is down on the weekly chart. Momentum is positive but showing a bearish divergence.


No trend on the daily chart. Momentum is negative.

EUR/USD moving average trends

Trend is down on the weekly chart. Momentum is negative.


Trend is down on the daily chart. Momentum is negative.

AUD/USD moving average trends

Weekly chart trend is down. Momentum is negative.


No trend on the daily chart. Momentum is negative.

Gold moving average trends

No trend on the weekly chart. Momentum is negative.


Down trend on the daily chart. Momentum is negative.

Silver moving average trends

Weekly chart trend is down. Momentum is negative.


Daily chart trend is down. Momentum is negative.