Moving averages are the cornerstone of my trading recommendations. I am a trend-follower and moving averages are the lines that make most sense for defining a trend, at least to my eyes. I don’t use subjective or even mathematically-drawn straight trend-lines that often, by contrast. Moving averages are more objective and work better in my experience.
Defining a trend with a moving average is very straightforward. If the price is above a particular moving average and especially if that moving average is itself rising, the trend is upwards. And if the price is below a particular moving average, and that average itself happens to be falling, we are in a downtrend. But which particular moving average to use? For me, using a longer one makes most sense, typically one of 55 periods.
Aside from 55, I use two other periods for moving averages: 13 and 21. These numbers are all, of course, members of the Fibonacci sequence. I do not attribute any magical properties to them, however. I am sure I could just as well use the more standard numbers of 10, 20 and 50. However, I have found 13, 21, and 55 to work rather well both in back-testing and in real-life trading.
I apply these same numbers for the moving-average periods on all the main charts I use for trading purposes, from the 10-minute chart at one end of the spectrum right up to the daily chart at the other end. (I also apply them to the weekly chart, but I seldom use weekly charts for trading as it is too long-term.)
Rather than using simple moving averages, I prefer to use exponential moving averages (EMAs). An exponential moving average is one that gives much more weight to the most recent prices that are used to calculate it, at the expense of prices further back in time. A simple moving average, by contrast, gives equal weighting to every single price. Once again, I have found exponential moving averages to give superior results to simple ones in back-testing.
Having identified a trend with reference to the 55-period EMA, I will usually shift to one of the shorter EMAs on the same chart in order to time my entry and exit. For example, let’s say the Dow’s price is above its rising 55-EMA on its four-hour chart. My bias is therefore to look for long positions. I might then open my trade when the price next comes back to around its 21-EMA, with a view to catching the next move up.
I never cease to be amazed at how often prices pull back right to the moving averages that I follow and then resume their prior trend. To determine when the price is bouncing off a moving average on a particular chart, I often switch to a chart of a lower timeframe. So, if the price is shown to be near an EMA on the four-hourly chart, I will then turn to the 10-minute chart to try to time my entry more precisely on that chart.
