Moving averages are one of the oldest and the most popular technical analysis tools. There are different types of moving averages, including simple, exponential, time series, triangular, variable, volume-adjusted and weighted. You can also calculate a moving average of another moving average.
For the sake of this discussion, I’m going to focus on the simple moving average, and apply the concepts to two different futures markets – the euro currency, and sugar. Keep in mind that moving averages are most useful in trending markets, and don’t work as well in sideways or choppy market conditions.
Simple Moving Average
A simple moving average (sometimes called arithmetic), is used to calculate the average price of a commodity at a specific point in time. It can be used as a basis to determine support and resistance points than can be useful for developing appropriate entry and exit points on trades. If the market’s price is above a specified moving average, that’s a bullish signal, and when it’s trending below, it’s bearish.
Calculating the simple moving average is just that—simple. A five-day moving average would result from taking data points from the prior five trading days, adding them together, then dividing by five. Which data points you use is up to you. Many traders will use the closing prices in calculating moving averages, but you can also incorporate the high, low and close into your calculations. Find what gives you a unique edge.
Timeframes
Moving averages are useful in suggesting a trend in either direction, and can be used in any timeframe. As a general rule of thumb, shorter-term traders would use moving averages based on shorter-timeframes. Very active day-traders who are in and out of the market quickly might even use five-minute, 10-minute or 30-minute time periods.
In general, the shorter the moving average timeframe the more sensitive it is likely to be. If you are long-term trader, you could get false signals if you rely on these. Some traders like to combine a short-term moving average with a long-term moving average. When a short-term moving average crosses over a long-term moving average (called a crossover), it is thought to provide a contrarian short-term signal.
Below are my guidelines on which time frames to use.
• Short-traders might focus on 5 – 25 day moving averages
• Intermediate-term traders might use 26 – 59 day moving averages
• Position traders might use 50 – 100 day moving averages
• Long-term position traders might use 100 – 200 day moving averages.
Applying the Concept: Euro Futures
Let’s now look at a commonly used moving average, the 20-day, for the euro currency futures. Each closing price is added for 20 trading days, divided by 20, and plotted on a weekly chart. A smooth line is created from these points, superimposed on the price chart.
If we see market trading under the 20-day moving average, that would be bearish for price action. When above, then it would be bullish. You can see how the market moved above and below the moving average in the chart at various points in time. This moving average can help you determine when to get in and out of trades at these prices points, which also act as important support or resistance.
As mentioned, you can plot other moving averages and see how the picture changes, depending on your trading timeframe. No matter which type you use, the moving average should define the trend. You can even plot weekly or monthly moving averages, based on weekly or monthly data points.
Applying the Concept: Sugar Futures
Let’s look at another market, sugar. You can see the uptrend in the weekly chart, as the market moved from $10 to $30 per pound, and how the market hugged the average. Then the market dropped steeply. We’ll look at a daily chart with a 20-day moving average as well. Some moving averages work better than others. In this case, the 20-day didn’t work quite as well, so you can try plotting a shorter moving average, such as a 14-day.
Also, watch your technical momentum indicators for confirmation. When you see (the Stochastic and/or Relative Strength Index turn bullish or bearish, you might want to tighten up your moving average time frame. As mentioned, the short-term the moving average, the more sensitive it will be.
This article just scratches the surface in terms of moving averages. One of the potential drawbacks of using a simple moving average is that it is a lagging indicator. That is, you are viewing what happened in the past. Exponential moving averages help alleviate this problem, by applying more weight to more recent data. I don’t think moving averages should be relied on exclusively in making trading decisions, but they can be a very useful tool to confirm other technical or fundamental indicators. I encourage you to explore this topic further, and contact me if you have any questions.
Jeffrey Friedman is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. For more information on this topic or others, he can be reached via phone at 866-231-7811 or email at jfriedman@lind-waldock.com.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
© 2010 MF Global Holdings Ltd. All Rights Reserved.
Futures Brokers, Commodity Brokers and Online Futures Trading.
141 West Jackson Boulevard, Suite 1400-A, Chicago, IL 60604.
