FuturesTechs Blog

One of the features we added when we made the free suite of levels is a collection of moving averages for each market we cover. These complement the pivot points and market profile levels which we had already been providing on a daily basis.

The moving averages are on 3 different timeframes: 10-day, 20-day and 50-day. We colour these numbers green when the 10-day is higher than the 20-day and the 20-day is higher than the 50-day, or red if the 10-day is lower than the 20-day and the 20-day is lower than the 50-day.

But why do technicians look at moving averages? The simplest way to put it is that the moving average is a smoothed trendline, and one of the most efficient ways of grasping the trend of any market. Unlike other technical tools (candlesticks and chart patterns, for example), the moving average is not designed to be an immediate predictor of future price action or key pivot points (though it does sometimes provide support and resistance levels). Instead, its job is to gives us a handle on the longer-term price direction. On the basis that trends tend to persist, aligning ourselves with this direction is usually to our advantage.

We use “simple” moving averages: this means that for the 10-day MA, for example, we simply calculate the average of the closing prices of the previous 10 days. There are other types of moving average (linearly weighted, exponential, etc.) which assign greater importance to more recent closing prices, or include data from all previous days using various different formulations for weighting the data, but the simple average remains the most commonly used.

As a lagging indicator, the moving average doesn’t react as soon as the price begins to trend, and it doesn’t reverse as soon as the trend changes course either. But in return for missing out on the exact start and finish of a trend, we get a measure of direction which doesn’t get knocked out by immediate fluctuations, helping us to stay true to the longer-term moves and resist trading too frequently.

There are a couple of variables which go into the makeup of the moving average. Apart from selecting which type of average to use, as already mentioned, we also need to choose the timeframe and the price to be entered into the calculation. While most people think that closing price is the most meaningful number as compared to the opening price or some other figure, there is no strong consensus about the choice of timeframe. The trade-off in this decision is between significance and responsiveness. A longer-period timeframe will certainly avoid being whipsawed and stay with the biggest moves, but it will also spend a great amount of time on the losing side when a trend changes course. A shorter-period timeframe will much better react to changes in trend, but will also get whipsawed more frequently and suggest more losing trades when there is a relatively weak trend.

One way to combine the best of both worlds is to use more than one moving average on the same chart. We can then look at moving average crossovers as buy and sell signals: when a shorter-term moving average crosses the long-term equivalent from below, we get a buy signal, and when it crosses from above, we get a sell signal.

This can work beautifully in markets with a well-defined trend. Using 10-week and 20-week moving averages to trade Brent crude oil, we would have got a buy signal on 19^th March, 2007 (closing price that day at $63.20), a sell signal on 25^th August 2008 (at $115.17), and a buy signal today (closing price somewhere around $52).

The problems arise in a trendless or choppy market, where the dangers of getting whipsawed increase and relying on moving averages can lead to ruination.

Suppose we tried to use 10-day and 20-day MAs to trade Brent crude in 2009, and in the most naïve way imaginable. How would it have worked out so far?

The horror show above doesn’t prove that these timeframes won’t work in the future (a rally from here could make the recent buy signal at $43.90 look inspired) but it does prove that they were the wrong timeframes to use over this trading period.

The lesson is that moving averages, as with any other indicator, must be used appropriately for the market under consideration, and in combination with other indicators and insights.

What we provide on our levels sheet are the 10-day, 20-day and 50-day MAs for the markets we cover, allowing members to get a feel for the price location in comparison to a decent selection of averages. As mentioned above, we point to the bullish or bearish alignment of these averages by highlighting them green when the 10-day is higher than the 20-day and the 20-day is higher than the 50-day, or red if the 10-day is lower than the 20-day and the 20-day is lower than the 50-day. Some traders who want to ride confirmed medium-term trends will wait for this kind of ultra-strong triple alignment before taking a position. The extreme case is when the price and moving averages are all aligned, and all moving in the same direction. Now that’s a trend!

But here’s a chart of the FTSE Index over the past 10 months, with the 10-day (red), 20-day (blue) and 50-day (black) MAs included, another example of the potential outcomes when using just one indicator:

Following the signals, and only closing out our positions when the moving averages turned to neutral, would have been great for the two downward moves in the first half of this chart. However, it also would have proved costly during the ranging market from November to January, which produced three false signals. To avoid being topped and tailed, we’d have to change the exit strategy during this time in order to take our profits much more quickly – something the moving averages will not help us to do. But the momentum of the averages should still be enough in most cases to ensure that the action continues in our direction for at least a few more points. Our level of confidence in the ability of the market to trend, combined with short-term indicators, should help to advise us on the correct course of action.

The point is that if you want to trade in the direction of a big trend, wait until you get the green or red highlights on our summary page. If the numbers are black, then there is simply no reason to get involved (at least, not from the point of view of the moving averages).

In the coming weeks and months we’ll be expanding the resources offered on our website to include exclusive files for our members covering new markets and new indicators. If there are particular markets or indicators you’d like us to cover, please let us know. For now, we hope you enjoy the levels sheet and find that the addition of the moving averages contributes to your successful trading!

Graham Neary (graham@futurestechs.co.uk)

Have a look at this “mystery” chart and tell me what you think?

Does anyone think this (whatever it is) is going down any time soon?

Hopefully we’re all thinking the same thing: That it looks very much like something that’s got a bright future, something that’s going up in the world. There doesn’t seem to be too much evidence that it is topping out, would you agree? In fact if this was a stock and you owned it you’d probably be more than happy to hold onto it, yes? And if you felt the market was going to head lower and you wanted to find a short trade to put on you probably wouldn’t chose something as strong as this, agreed?

It was Charles Dow almost 100 years ago who suggested we can define an uptrend as a series of higher highs and higher lows. In contrast a downtrend is defined as lower highs and lower lows, which brings me on to the next chart.

As you can see this is a chart for Royal Bank of Scotland between October 2006 and the present (August 2008 in case you’re reading this in retrospect). Now I’d like to point out straight away that I could have chosen any number of bank stocks from any number of countries for the purpose of posting this blog. I used RBOS because I’ve got a couple of mates who work there and I’ve got a sadistic streak. Sorry fellas.

Because I think it’s fair to say this chart is quite a bit different to our first chart, wouldn’t you say?

Well the eagle eyed amongst you may actually have noticed that it is actually THE SAME CHART, but “flipped”. We have effectively put a mirror below the real chart to create our “mystery chart”. So the mystery chart is RBOS with 7 quid at the bottom and £1.50 at the top.

Now think about the paragraph above, and think about your reactions when you read it. I would imagine it was something like this:

“… it looks very much like something that’s got a bright future (I agree!), something that’s going up in the world (yes indeed). There doesn’t seem to be too much evidence that it is topping out (too right, it’s a stonker!) , would you agree? (yes) In fact if this was a stock and you owned it you’d probably be more than happy to hold onto it, yes? (yes please, love it!!). And if you felt the market was going to head lower and you wanted to find a short trade to put on you probably wouldn’t chose something as strong as this, agreed? (agreed, let’s short something else, surely).

Which brings us to the title of this Blog: “The most common question of 2008″. Which is, of course “Should I buy Bank Stocks?”. I reckon you just answered your own question!!

NOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO!!!

If you want to gamble go to a casino. If you want to play the stock market or make money spread betting follow some simple rules and don’t just put on stupid high risk trades. I’m sick of being asked this question. It’s a joke. It’s simple: Don’t buy things that are still going down.

Let the pros tell you when to buy, ie let the market tell you when enough professional buying has happened in a Stock that it is now in an uptrend.

If you “flip” the chart and there’s no way in the world you would SELL our mystery chart, then what the heck are you doing even thinking about BUYING it when we put it the right way round?

The point I’m making isn’t that Bank stocks haven’t bottomed out. They might have done, but there isn’t enough weight of evidence yet. It’s a dangerous trade, and there’s no need to rush in. These stocks could go sideways for years now, or even keep heading lower, after all we haven’t broken our series of lower highs and lower lows yet, have we?!

Can I finish by saying that we have the chappies at Updata to thank for making “flip” a standard part of many charting systems these days. I’m pretty certain it wasn’t until they started to expound exactly what I’ve done above.

Cheers,

Clive.

PS. August is turning out to be a bit of a damp squib in Equity markets so far, and the best advice I can give is to suggest you don’t get too carried away if you’re trading Equity Indices like the Dow and the FTSE. The market has a habit of taking money off of you in quiet periods. There could be some really solid trends to trade between now and the end of the year. Don’t take yourself out of the game trading during low volume quiet periods like now.