By David Adams
One of the simplest and informative trading indicator one can utilize is some version of a moving average. I use them in my own trading, and you should consider doing the same. They are simple in structure and most charting programs have several different types of moving average formulas built into their indicator package.
In my trading, I strike an 89 period moving average on every chart I trade. If the price action is significantly below the 89 period moving average, or has spent most of the day below the average, I simply eliminate any long trade from my thinking.
Why?
I hate trading against the trend and prolonged action significantly below the 89 period SMA tells me the trend for the day is short. Not wanting to imitate a salmon swimming upstream, I simply concentrate on short trading for the rest of the day and avoid the pitfalls of counter trend trading. I realize some people absolutely love digging out that one great countertrend trade, because often they are big gainers, but the number of countertrend trades that set-up looking great, then turn tail back short far outweigh my risk tolerance. I let the others hit the home runs, and settle for three or four singles, with an occasional double thrown in for good measure. In any event, trading with the trend keeps me out of harms way and those devastating big losing trades. I also use the formula for long trades, if the price action is significantly above the 89 period SMA, or stays above the 89 period SMA for a prolonged time, I eliminate any short trades from my thinking. Same principle, I want to stay in the trend.
If the price action is alternating above and below the 89 period SMA all trades are on the table, as no clear trend is established. Further, I don’t concern myself if the price action is one to three points within the 89 period SMA because this certainly isn’t significant deviation from a daily trend. Normal market noise will have the price action oscillating above and below the moving average. No, I am looking for major breaks below the 89 period SMA for my decision process.
So, what is a simple moving average, anyway?
Let use a simple five period simple moving average. The last five periods price has been:
5+6+5+7+4=27 (27/5)=5.4
So the moving average for this five period average has been 5.4. As each period passes a new SMA is calculated and a smooth line connecting these points forms. Voila! You have yourself a moving average line. It’s not uncommon to calculate two different moving averages simultaneously and gauge your entries and exits based on the intersection of these lines. The length of the time period for each SMA depends entirely on the time frame of your trading, with longer term traders using much longer SMA period numbers and short term traders using much shorter SMA period numbers.
Try incorporating some of these moving average techniques into your own trading and you may find a bounty of information you have been missing. Moving averages are valuable tools in the trading process and because of their simplicity are often overlooked.
I endorse a state of the art trading program for beginners at Trading Concepts, Inc It’s an awesome product that will have you well on your way to success. Plus, it has a money back guarantee…you have nothing to lose and thousands to gain.