Using Simple Moving Averages The Evans Group LLC

Post on: 14 Июль, 2015 No Comment

Using Simple Moving Averages as a Leading, not lagging, Indicator

Moving averages do not predict a price direction, but according to www.stockcharts.com “define the current direction, with a lag”, and “smooth the price data to form a trend following indicator”.

Most believe moving averages “lag” as they are based on past prices.

In my work at www.bluechipoptions.com. our 7 year in a row Reader’s Choice award winning option advisory service[1] we use moving averages as a “leading indicator working with Bollinger Bands on point and figure charts to help to analyze not what was, but to “eliminate noise” to see the prior trend, and what happened.

Many traders use the simple moving average (SMA) or exponential moving average (EMA) to identify the direction of trend and to see support/resistance and pivot points.

A moving average is based on number of days; a 10-day SMA is the sum of closing prices of the stock or option (yes, it works on cash derivative options on the DIA, SPY, SPX and OEX very well) divided by the number of days. The average “moves along the time scale”.

Chart schools teach the SMA as lagging because it is using “past data”, and because it “drops” the first data point as a new 10 day average (or whatever the time period chosen) each day. Exponential moving averages (EMA) apply more weight to the most recent data by calculating the SMA, creating a weighting multiplier, and creating the EMA. Formulas for this methodology are easy to find in all online charting schools.

It’s much simpler than we make it, and much more predictive when viewing either an EMA or SMA using Point and Figure charting.

Point and figure charting eliminates “all noise” and www.bluechipoptions.com we use a variety of ratios and time periods to see “very little so we see much more”.

Here’s an example:

This chart of the Dow is:

-daily (using data from 3/2/15)

-uses a 3:1 ratio on the movement to cut out clutter

-shows upper and lower Bollinger Bands

-uses a 20 day Average True Range (ATR)

-uses a 20 day SMA

From this chart 17, 050 hits the lower Bollinger Bands, and 17,800 the higher Bollinger bands, and 17, 450 as the SMA. The top shows at 18,253, which to our eyes shows an overbought market far over the Bollinger Bands, far above the moving average, and having surpassed a “double top breakout” on February 13, 2015.

Now, view the same chart with a few changes:

This chart of the Dow is also daily, but changes variables:

-ATR vs. Traditional

-Box size .50 vs. the norm of 1.0

-Reversal at 2.0 vs. the norm of 3.0

-SMA of 10 days

Now we are with a new top/bottom of Bollinger bands, a new lower support line at 17, 383, which is also the SMA. Option traders for the Dow, using the DIA, well see support and resistance lines (inverse) at 17, 894, 17,722, 17, 553, and at the SMA. As the market when this is written is at new highs, no new resistance lines exist, nor any Bollinger Band.

Retracement we use our version of “magic numbers” that seem to hold support and resistance lines, and fit with numbers, no matter what 000’s they are with (5000, 1,6000,00, 18,000 as examples). 747-827 always appear to be “support or resistance” in all cash derivative options, and in all stock ranges. I find many other sequences like these because of point and figure charting. [2] Schooled in this Charles Dow manual count and no noises simplicity of PnF charting, it’s easy to see more clear to see why the Simplicity of the Market is its Greatest Disguise©.

While writing this article I consulted with a number of stock traders and economists, and gathered ideas of how others use SMA.

“Suggestion: plot a 5-period SMA of 1-day S&P500 ATR, and watch what happens when the ATR tilts below 10, or pops over 40”[3]

Here’s how such a chart looks, two ways:

Using Point and Figure charts:

2. Using a Candlestick chart showing Bollinger Bands, RSI, and MACD, with a 5 day SMA, using the suggestions above:

Another trader creates up to 3 SMA on a graph. He says, “The data is at least a day old unless the market is closed. It does give you a choice on the moving averages, which might change on your time horizons. I use 5, 13 and 21 day moving averages most often, but it also will allow you to enter the first desired and then double it, then double that again. You can also choose to use or not use 1 to 3 averages.”[4]

Simple moving averages can be used simply. I believe that creating flows of daily, weekly, and to the hour PnF charts, using Average True Range (ATR), and Bollinger Bands, helps eliminate noise allows the SMA to smooth the trader’s noise of viewing too much information.

In a Nutshell:

“The basic function of moving averages is to raise the contribution (weights) of old data at the cost of the distribution (weights) of the younger data”. [5]

A Simple Moving Average may be better suited to identify support and resistance lines, and use of the SMA is a confirmation of these lines.

Longer moving averages show more of the lagging of the indicator. A 10-day simple or exponential moving average will turn only after prices turn. Use of shorter SMA’s, or overlays of different time periods, may prove more valuable for option and/or momentum stock trading.

A simple moving average used in overlay of a number of different “days counted” can create a moving –average crossover, as by smoothing the traces of these moving averages cross, and show trends.

Faster moving averages (5, 10, 25 day) show the short term trend, while 50, 100, 200 day averages show cycles, and smooth out price “noises” more effectively.

If one uses both a short and longer term SMA using a Point and Figure (PnF) chart, or an O/H/L/C bar chart the overlay where the shorter term crosses the longer term is often a meeting point to enter or exit the market.

Chip Evans, Ph.D. is the President of The Evans Group LLC, a business consultant company www.theevansgroupllc.com and the 7 year award winning stock and option educational and trading service/system www.bluechipoptions.com