• 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