Chapter 9 Moving averages

Introduction The moving average is trend-following device and is a basis for many trend-following systems. Moving average (MA) is a curving trendline. Simple MA, MA10: the recent 10 days closing price average. Linearly weighted MA Exponential MA Adaptive MA (AMA) by Kaufman There is no evidence to prove that exponential MA works better than simple MA. Moving averages can also be used on open interest and volume figures.

The use of moving averages (prices crossing MA several times during sideway prices stay above MA during uptrend)

The use of moving averages 20d MA and 200d MA (watch shorter MA crossing during sideway )

The use of moving averages Exponential MA is more sensitive than simple MA

The use of moving averages One MA [Signal] When the closing price moves above the moving average, a buy signal is generated. [Confirmation] For confirmation, some would like to see the moving average line itself turn in the direction of the price crossing. (Figure 9.3) Two MAs (Double crossover method) [Signal] A buy signal is produced when the shorter average crosses above the longer. (for confirmation, like one MA, the longer MA turn up) *(5-20 day MA) A buy signal occurs when the 5 day average cross above the 20, and a sell signal when the 5 days move below the 20. *??(10-50 day MA) the 10 day crossing above the 50 signals an uptrend; a downtrend takes place with the 10 slipping under the 50. The two MAs method lags the market a bit more than the use of one MA, but produces fewer whipsaws.

One MA

The shorter and longer MAs *The shorter and longer MAs *** The longer the averages work better as long as the trend remains in force, but a shorter average is better when the trend is in the process of reversing.

Two MAs * Watching longer MA direction before using shorter MA crossing to trade

Two MAs (* using 10d and 50d MAs in stocks)

The use of moving averages (Future) Three MAs (Triple crossover method) 4-9-18 day average is mainly used in future trading, a variation of 5-10-20. (Allen) Figures 9.7a-b [Signal] A buy signal takes place in a downtrend when the 4 day cross above both the 9 and 18. [Confirmation] A confirmation occurs when the 9 day crosses above the 18. This places the 4 day over the 9 which is over 18. * Some intermingling may occur during corrections or consolidations. When the uptrend reverses to the downside, the first thing that should happen is that the 4 day dips below the 9 and 18 (sell alert). A confirmation occurs when the 9 drops below the 18.

4-9-18 days moving average system-Figure 9.7a (Future)

4-9-18 days moving average system-Figure 9.7b (Future)

Moving average envelopes A single average can be enhanced by surrounding it with envelopes. Percentage envelopes is used to determine if a market is overextended in that direction.(指overbought, oversold) Short term: 3% envelope and 21day MA (Figure 9.8a) *Long term: 5% envelope and 50 days (10 weeks) MA, see Figure 9.8b; 10% and 200 days (40 weeks)

Short term envelope: 3% envelope and 21days MA

Long term envelope : 5% envelope and 50 days MA

Bollinger bands Two standard deviations are placed above and below the 20 day average, 95% of the price data fall in the envelope [Overbought/oversold] Price touch the upside/downside During the sideways period, prices touch outer bands (both sides). [Alert] In a strong uptrend, prices fluctuate between the upper band and the 20 day average (Figure 9.9a). In that case, a crossing below the 20 day average warns a trend reversal to the downside. (MSFT) [Tactic] Using a 20 weeks average in a sideways, each touch of the lower band signals a buy opportunity. (Figure 9.9b) [Tactic] touch of a 20 weeks average signal a buy chance in an uptrend.

Bollinger bands

**20 weeks Bollinger bands and market bottom

Bollinger bands Band width measures volatility: During a period of rising price volatility, the distance between the two bands will widen. Conversely, during a period of low market volatility, the two bands will contract. When the two bands are far away, this is often a signal that the current trend may be ending. When the distance between the two bands are too narrowed, this is often a sign that the market may be about to initiate a new trend. Long term: 20 weeks or 20 months (100 days or 400 days) *Bollinger bands work best when combined with overbought/oversold oscillators to confirm. (20 weeks BB)

Apply MA to long term charts The 10-40 weeks (50-200 days) MA can be used to help track the primary trend on weekly charts for stocks and future. (Figure 9.10) 13 weeks average has proven valuable in both stocks and commodities. p213 10-30 weeks MAs and 13-40 weeks MAs have long been used in stock market analysis. The meaning of “Moving averages as oscillators” is that We can construct an oscillator by comparing the difference between two moving averages. For example, MACD is used partially as an oscillator.

40 weeks MA provide support/resistance in long term charts (200d MA in 5 years)

Summary The longer averages work better as long as the trend remains in force, but a shorter average is better when the trend is in the process of reversing. Moving average work best when the market is in a trend. It performs poorly when the market is traded sideways (non-trend), which is 1/3 to ½ of the time. The purpose of trend-following systems (see p 215) are to identify and then trade in the direction of an existing trend. *A non-trending method like an overbought or oversold oscillator is more appropriate during a sideways market.

Summary Stock traders rely heavily on 50 days and 200 days averages. Bollinger bands make use of 20 day and 20 week moving averages.

Further topics The 4 week rule is used primary to future trading. Optimization allows technical parameters to adapt changing market conditions. * Adaptive moving average (AMA) moves more slowly when markets are trading sideways, but then moves swiftly when the market is trending. AMA constructs an efficiency ratio by comparing price direction with the level volatility. Centering the average means to place it in the middle of the time period it covers. p. 211 The moving averages can be adjusted to fit the dominant cycles in each market. p. 212 Fibonacci numbers are used in moving averages. p. 212