CHARTS, TRENDS, AND PATTERNS - Section 2 - Chapter 7 Part II - Strategies using Moving Averages

1. Lecture - 16
Strategies Using Moving
Averages
CMT LEVEL - I

2. CMT LEVEL - I
Learning Objectives
 Strategies Using Moving
Averages
- Determining Trend
- Determining Support and
Resistance
- Determining Price Extremes
- Giving Specific Signals
 Confirmation of Trends
with Moving Averages
 Using Multiple Moving
Averages

3. Strategies for Using Moving Averages
Support &
Resistance
Determining
The Trend
Price
Extremes
Specific
Signals

4. Determining The Trend
• Moving averages are used as a
measure of trend. The most common
usage is comparing the current price
with the moving average that
represents the investor's time horizon.
• Many investors use a 200-day moving
average. If the stock or market average
is above its 200-day moving average,
the trend is considered upward.
• Conversely, if the stock or market
average is below the 200-day moving
average, the trend is considered
downward.

5. Support & Resistance
• The moving average often acts as
support or resistance.
• A Moving Average often duplicates
the trend line, we also called Adjusted
Trend Line.
• Moving Averages can be an easy
trailing stop mechanism for
determining when a position should
be liquidated or reduced.
• WMT halted its rally in late November
at the moving average and again
halted its decline at the moving
average in early December.

6. Price Extremes
• Moving average is a mean, any reversion to the mean will tend to approach
the moving average.
• Price has a tendency to return to the mean.
• Thus, a deviation from the moving average is a measure of how much prices
have risen or fallen ahead of their usual central tendency, and being likely to
return to that mean, this deviation then becomes an opportunity to trade with
and against the trend.
• Trading against the trend is dangerous and requires close stops, but the
reversion also provides an opportunity to position with the trend when it
occurs.
• In addition, when prices continue substantially away from the trend, they are
often signaling that the trend is changing direction

7. Price Extremes

8. Specific Signal (Crossovers)
• Technical Analysts use moving averages to give specific signals. These can occur
when prices cross a moving average, when a shorter moving average crosses a
longer moving average, and in some cases, when a third, even shorter, moving
average crosses two longer ones.
• Generally, using two moving averages and their crossover as a signal has been
successful, but with substantial drawdowns in capital in sideways markets because
of the many unprofitable small trades that occur from the many false signals.
• Methods, such as using the ADX, described in the next section, have been
developed to determine if prices are trending at a rate at which a moving-average
crossover system will work.
• The MAMA-FAMA system described previously and other methods of adapting
moving averages to changes in volatility are aimed at solving this drawdown
problem.
• However, it will not go away, and thus, although the crossover methods are
profitable over time, the investor must have patience and enough capital to
withstand a series of small losses until a trend develops.