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A Different Type of Moving Average
Virtually every trader has dabbled with or experimented
with some sort of moving average. What I want to introduce
you to in this lesson is a different sort of moving
average cross method, which I have found to be very
good at identifying short term trend changes.
As we know a moving average is normally plotted using
the close of a bar e.g. if you were plotting a 3 period
moving average, then you would add the last three closes
and divide the total by three to get a simple moving
This is where I want you to think a little differently.
I have always been an advocate of taking traditional
thinking and changing it around. What if you used the
open instead of the close? What if you used the close
of one period of a moving average and the open of another?
First, most charting packages will allow you to use
the open, high, low or close to plot a moving average.
|In the example below of the daily Dow Jones,
I have used a 5 period exponential moving average of the
close and a 6 period exponential moving average of the
open. As you can see it catches the short term trend changes
|In the next example of the 1 hour EUR/USD,
you can see that the close/open combination worked really
well. Of course you will go through periods of consolidation
with any market and any moving average method you use
will be whipsawed. To get around this you need some sort
of filter or approach that helps you keep out of the low
You could use ADX, Stochastic or MACD to help filter
the noise but I also like to add a time frame.
|In the next example of the 4 hour GBP/USD you can see
that on the 24th September 04 at 4:00 there was a cross
of the 5 period exponential moving average of the close
above the 6 period exponential moving average of the open.
This signal has remained in place until today as I write
on the 27th September.
|Although there was a signal on the 4 hour,
to help identify even better entry points you can drop
down a few time frames to the 30 minute chart. As you
can see from the 30 minute chart there have been quite
a few crosses of the 5 period exponential moving of the
close above or below the 6 period exponential moving average
of the open.
There are lots of ways to trade this but a neat little
trick is to wait for the signal on a higher time frame
and then drop down a few time frames and wait for a
pullback. The first signal after the pullback on the
lower time frame is normally a pretty good entry point
e.g. If there were a cross up on the large time frame
then drop down to a lower time frame and wait for the
retrace and then give another buy signal (cross up).
The opposite is true for short signals.
Once you get the signal on the shorter time frame depending
on where support is you can usually place your first
stop loss under the nearest support area (valley). If
the market begins to make progress you can move your
stop so that it trails the market by moving your stop
to just under the most recent support area.
In this lesson I have use an exponential moving average
but experiment with different types of average such
as weighted, smoothed or simple. You can also experiment
with different lengths of moving average.
Information, charts or examples contained in this lesson are for illustration and educational purposes only. It should not be considered as advice or a recommendation to buy or sell any security or financial instrument. We do not and cannot offer investment advice. For further information please read our disclaimer.
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