V.10:8 (358-360): Filtering Trades With A Moving Average Slope by Adam White

Filtering Trades With A Moving Average Slope by Adam White

Moving averages are attractive because they simply and reliably execute the "cut your losses and let your profits run" strategy. Moving averages also have drawbacks, however, in that they discard much of the information that the market offers. A simple moving average represents simple quantified information — either prices are above it or below it. Can additional information, in this case the slope of the moving average, be put to use to improve trading performance? Adam White of the Technical Traders Bulletin shows you how.

Despite the theories to the contrary, a simple filter device can eliminate the losing trades of a simple moving average reversal system. Although other, more valuable applications of the moving average slope are bound to exist, keeping matters simple will, with any luck, be a more suitable introduction of the main idea.

Since moving averages tend to be smooth, short subsections approximate straight lines. Measuring the slope of a straight line is fairly straightforward—simply calculating the line's standard deviation does the trick. When the slope of a short line is low, the vertical distance between the two endpoints is small, and as the slope increases, the vertical difference between the endpoints increases. As a result, the standard deviation of a short subsection of a moving average is low when its slope is low and in turn high when its slope is high.