Trading Ranges With Moving Averages by John Sweeney
Using simple moving averages may seem like a straightforward approach to trading, but there are subtle techniques that can improve performance.
A few months ago, I pointed out that moving averages are neat boundaries for trending action. Short-term averages are also handy for finding yourself in a trading range. How can that be, you ask? Usually, averages are curses for their behavior in a trading range. Those who use them to enter trends find themselves trading in and out rapidly, usually losing money in the process. By the very nature of moving averages, the delay built into them make for bad decisions — a trend-entry trade — when, in fact, prices have found a level and are simply oscillating around it. You end up going long or short just as prices head down or back up into the range.
However, you can turn this behavior to achieve your own ends by observing that the very characteristic of an average in a trend is that it is not crossed by price. In an uptrend, it’s below price and in a downtrend, it’s above price. If price has crossed your trending average (Figure 1, point 1), your antenna goes up. Here is the first indication that a trading range is forming, not that a new trend is taking place. Perhaps support and resistance have been hit and price is about to start fluctuating in a relatively fixed area. Just in case this is so, label the crossing “1” and the previous low (or high, if you were trending long instead of short) “2.”