Moving averages are the most popular directional gauges. They are typically the first technical indicator in the novice trader’s toolbox. Many professional traders rely on them as well. Typically, the directional signals come when a short-term MA crosses a long-term MA. The problem with this method is that by the time the averages converge and cross the directional move is already well on its way. Thus, entering a trade using this method usually leads to late entry and poor trade location. Bad trade location increases risk and reduces profits.
To improve entry, many traders use exponential moving averages (EMA). These are calculated with more weight on the most recent prices. Thus, they tend to converge and cross faster than simple MAs, which should lead to better trade location.
Calculating Moving Averages
Most MAs are calculated using the close of the day. But for intraday or short-term traders, these MAs are often useless when volatility is high. Day and swing traders frequently use daily pivot levels for short-term directional signals. These indicators can be calculated in many ways. Maybe the most popular is to take the average of the daily open, high, low, close. If the market closes below this average price, it means sellers have the edge; a settle above this price, bulls gain the advantage.
I consider myself a swing trader most of the time. To me, that means my projected profit on a trade is roughly the length of an average week measured higher or lower from the price at which I take a position.
Designing Pivots
I designed a pivot that suits my time frame and style. To calculate this pivot, I take an average of the high, low, close over a three-day period, so the pivot is an average of nine prices. If the close is below this pivotal price on the third day, odds favor a move lower over the 24-hour period. On the other hand, a close above this MA means long positions should pay the next day or longer.
There are no right or wrong technical indicators. They all have merit at some point depending on market conditions. Each trader must find the technicals and time frames that fit their personality. Through experimentation I found my niche. Along with some other gauges, the three-day pivot suits my style. The average amount of time you intend to spend in a trade may dictate the pivotal price you should calculate.
The Importance of Timing
Trading style and the indicators you choose differ depending on time frame. Long-term traders, fund managers as well as many business news programs focus on the industry standard moving averages, or 50- and 200-day MAs. However, if you are a swing or day trader those long-term averages are often useless when creating strategy.
Time is a forcing point. As a broker and educator, I’ve noted that many traders speak of trades in terms of time. Some might say “I had a great day or bad week.” Or “trading has been difficult this month” or “I need a good quarter.” The time you put in watching screens will dictate the moving averages you should use.
I prefer to focus on swing trades for 5- to 10-day positions. It does not mean I always hold positions that long; I just hope the trend will be in my favor for that period. Therefore, I use shorter times for my technical indicators. When swing trading I like to use a 5-day MA against a 20-day MA. There are 5 sessions in a week and about 20 in a month. Assuming time is a forcing point, it seems logical to watch MAs that suit my preferred time frame.
When day trading, I like to use 30-minute bar charts. There are around 14 30-minute periods during a regular trading day. So, for intraday directional signals I prefer a 9- vs. 14-moving average (30-minute bars) crossover for short-term directional signals.
A Final Hint
Another helpful hint when using MAs is to calculate the difference between the two. When the difference between the averages is below a benchmark, odds for a trend or breakout increase. Thus, buying options might be the best choice. On the other hand, when the divergence of the averages is well above a historic average, chances are the trend is near exhaustion. In this situation, option spreads may be the better bet.
John Seguin
Senior Technical Analyst
Market Taker Mentoring, Inc.
