- Moving Averages
- How to Calculate
- How to Interpret
- MACD
- MACD Histogram
Moving Averages
- The moving average is a trend following indicator
- It does not predict future market action but follows it
- Moving averages are used to identify the direction of the trend and define potential support and resistance levels
- It can be viewed as a curving trendline
How Many Period to Average?
- The critical element is the number of time periods used in calculating the average
- The key is to find a moving average that will be consistently profitable
- Short term traders use 05-25 Period averages
- Medium term traders use 26-49 Period averages
- Long term traders use 50-200 Period averages
Which Price to Average?
Most moving average calculations are based on closing prices but can also be constructed using:
- High, Low, Open
- Median Price (H+L/2)
- Typical Price (H+L+C/3)
- Weighted Close (H+L+C+C/4)
Simple Moving Average - Criticisms
- The Simple Moving Average gives room to some criticisms
- The first criticism is that only the look-back period covered by the average is taken into account
- Another criticism is that the simple moving average gives equal weight to each of the look-back periods
Types of Moving Averages
- The only significant difference between the various types of moving averages is the weight assigned to the data
- Simple moving averages apply equal weight to all prices
- Exponential and weighted averages apply more weight to recent prices
- Triangular averages apply more weight to prices in the middle of the time period
- Variable moving averages change the weighting based on the volatility of prices
Interpretation I - Bullish Price Crossover
- Compare the relationship between the moving average and the security’s price
- A bullish signal is given when prices rise above the moving average
Interpretation I - Bearish Price Crossover
- Compare the relationship between the moving average and the security’s price
- A bearish signal is given when prices fall below the moving average
Interpretation II - Double Crossover
- The second interpretation uses two moving averages to generate signals
- This is called the “double crossover method”
- The technique involves one relatively short moving average and one relatively long
- The length of the moving averages defines the timeframe for the system
- A 5-day MA and 20-day MA for short-term
- A 50-day MA and 200-day MA for long-term
Interpretation II - Bullish Double Crossover
- Bullish Crossover occurs when the shorter average crosses above the longer one
- The crossover of a 50MA above the 200MA is also known as a golden cross
Interpretation II - Bearish Double Crossover
- Bearish Crossover occurs when the shorter average crosses below the longer one
- The crossover of a 50MA below the 200MA is also known as a death cross
Interpretation III – Triple Crossover
- The triple crossover technique uses three moving averages
- The third moving average helps avoid false signals encountered in the double crossover technique
- The most popular combination was mentioned by R.C. Allen and uses the 4-9 and 18 period moving average combination
- The 4 day will follow the trend most closely, followed by the 9 day and then the 18 day
Interpretation III - Bullish Triple Crossover
- For a buy signal, the 5-day average should be above the 10-day, and the 10 above the 20-day
- If the 5-day is below the 10-day average, the signal is not valid
- The entry should be activated only if the 5-day crosses above the 10-day average while the 10-day average is still above the 20-day average
Interpretation III - Bearish Triple Crossover
- For a sell signal, the 5-day average should be below the 10-day and the 10-day below the 20-day
- If the 5-day is above the 10-day average, the signal is not valid
- The entry would be activated only if the 5-day crosses below the 10-day average while the 10-day average is still below the 20-day average
Moving Average Ribbon
- The moving average ribbon is constructed by combining eight or more moving averages
- Four short term exponential moving averages (4,7,11,16)
- Four long term exponential moving averages (25,30,35,40)
- The short-term averages group represents short term traders’ view of the market
- The long term averages group represents longer term traders’ view of the market
Moving Averages in a Range
- Moving Averages work very well when the market is trending
- In a range they generate many false signals known as whipsaws
Moving Average Convergence/Divergence
- Also known by traders as “M-A-C-D”
- Developed by Gerald Appel in the late seventies, the MACD is considered one of our best mathematical tools
- It is a hybrid indicator that can be used as a trend following or even momentum indicator
MACD - Calculation
- The MACD is made up of two plots
- MACD Line: (12-period EMA – 26-period EMA)
- Signal Line: 9-period EMA of MACD Line
Interpretation I - Centerline Crossover
- Centerline Crossover – MACD Line VS Zero Line – used for trend direction
- Bullish centerline crossover occurs when the MACD moves above the zero line to turn positive
- Bearish centerline crossover occurs when the MACD moves below the zero line to turn negative
Interpretation II - Signal Line Crossover
- Signal Line Crossover – MACD Vs Signal Line used for price corrections
- Bullish crossover occurs when the MACD turns up and crosses above the signal line
- Bearish crossover occurs when the MACD turns down and crosses below the signal line
MACD Histogram
- Thomas Aspray developed the MACD Histogram in 1986
- It measures the distance between MACD and its signal line
- The histogram signals trend changes well in advance of the normal MACD signal but is less reliable
MACD Histogram - Calculation
- MACD Histogram: (MACD Line – Signal Line)
- When MACD is crossing below its signal line, is when the MACD Histogram is moving below zero
- When the MACD is crossing above its signal line, is when MACD Histogram is going above zero
MACD Histogram - Interpretation
- The MACD-Histogram anticipates signal line crossovers in MACD
- Its downward slant implies negative divergence between MACD and its signal line and is bearish
- Its upward slant implies positive divergence between MACD and its signal line and is bullish
