Sharpening Your Trading Skills With Moving Averages

I use a "toolbox" approach to analyze and trade markets. The more technical and analytical tools that I have in my trading tools that I want, the better my chances of success in trading. One of my favorite "secondary" trading tools is the moving average. First, let me give you an explanation of moving averages, and then I will tell you how I use them.

Moving averages are one of the most commonly used technical tools. In simple moving averages, the mathematical median of the underlying price is calculated during the observation period. Prices (usually closing prices) during this period are added and then divided by the total number of time periods. Every day of the observation period is given the same weight in a simple moving average. Some moving averages give greater weight to newer prices in the observation period. This is called an exponential or weighted moving average. In this educational feature, I will only discuss simple moving averages.

The length of time (number of bars) calculated in the moving average is very important. Moving averages with shorter time periods usually fluctuate and tend to give more trading signals. Average movements are slower using longer time periods and display smoother moving averages. However, a slower average might be too slow to allow you to set long or short positions effectively.

Moving averages follow trends while facilitating price movements. Simple moving averages are most often combined with other simple moving averages to show buy and sell signals. Some traders use three moving averages. Their length usually consists of short, medium and long moving averages. Systems commonly used in futures trading are 4-, 9-, and 18-period moving averages. Keep in mind that time intervals may be ticks, minutes, days, weeks, or even months. Usually, moving averages are used in shorter time periods, and not on weekly and monthly long-term bar charts.

The normal "buy/sell" signals of the moving average are as follows: Buy signals are generated when the short-term average crosses from the bottom to the long-term average. Conversely, sell signals are issued when the short-term average crosses from top to bottom of the long-term average.

Another trading approach is to use closing prices with a moving average. When the closing price is above the moving average, maintain a long position. If the closing price falls below the moving average, liquidate long positions and make short positions.

Here is an important warning about using moving averages when trading futures markets: They do not work well in choppy or non-trending markets. You can develop a severe whiplash case by using a moving average in a sloping and sideways market. Conversely, in a trendy market, moving averages can work very well.

In the futures market, my favorite moving averages are 9 and 18 days. I also use a moving average of 4-, 9 and 18 days on occasion. When looking at daily bar charts, you can plan different moving averages (provided you have the right diagramming software) and immediately see if they have worked well in giving buy and sell signals over the past few months from price history on the chart.

I say I like the moving average of 9 days and 18 days for the futures market. For individual stocks, I have used (and other successful veterans told me that they are using) a 100 day moving average to determine whether a stock is bullish or bearish. If the stock is above the 100-day moving average, it is bullish. If the stock is below the 100-day moving average, it is bearish. I also use a 100-day moving average to measure the market for the health futures index.

Another little wise advice: A veteran market observer told me "commodity funds" (large trade funds that often dominate futures market trading) followed a 40-day moving average very closely - especially in the futures market. So, if you see a market that is ready to cross above o

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