Tag: Moving Averages

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The Key to Trend Analysis

The Key to Trend Analysis

As I mentioned in my last article, the difference between the 18 moving average and the 20 moving average is very small.  I believe the techniques described on this website and in my videos can be employed by any intermediate term moving average line 18 to 22 periods in length.  If you prefer to use a 20 MA instead of 18 MA, that is fine.  However, stick with it.  Please do not switch back and forth.  Your mind will learn to assimilate to whichever MA lines you choose.  But, if you continue to switch the lines, your subconscious mind will never be of service.  I know from my own experience after using the same MA lines in viewing millions of charts over the years that there are times where I know what is coming (an intuitive feeling) but I have a difficult time explaining it to my clients in the form of hard facts.  This is the subconscious mind taking over and it can be a powerful tool in chart reading.  It will only work after your mind has processed thousands and thousands of charts which have the same look to them. 

Whichever length you choose, this intermediate term moving average is the most important component in this strategy.  While I use the 18 MA and the 40 MA as a buddy system, it is the 18 MA which really drives this approach.  The position of the 18 MA on the monthly chart will play a large role in defining your longer-term investment strategy for a given instrument.  It has the same effect as the wind blowing at your back when riding a bike.  If you have ever tried to ride a bike on open road with the wind in your face, this will give you the sensation of what it is like to make a long-term investment when the 18-month MA is working against you, i.e. bad weakness. There are very few exceptions to this rule.  The monthly chart of Amazon (AMZN) below shows what can take place when the 18-month MA line is working for you.  This line has been rising since 2009 except for a pause in 2014 where it flattened but never turned down.  As long as this MA has good upward slope, the long-term trend is bullish with good momentum.  The slope of this line is important to monitor.  I have bolded the line on the next few charts to show that the 18 MA on each timeframe is the driver for this approach and quite often will be the same as the trendline if it were drawn in.  Also, it tends to

provide support on pullbacks when it is rising and offers resistance on rallies when it is declining.  It is a moving line so it is an area of support/resistance as opposed to an exact level. The monthly chart of Walmart (WMT) is a good example of how the slope of the 18 MA helps to provide a bias for the long-term trend.  Since we are using an 18-month MA, it is considered the long-term trend.  An 18-week MA would be considered the intermediate-term trend.  The first shading on the WMT chart shows a flat period for this MA line and that puts the bigger picture trend in the neutral camp until the breakout in early 2012.  Then, in late 2014, a sharp selloff turned the 18-month MA lower.  There was no

confirming price evidence of a change in trend (explained in the 1-2-3 Change in Trend article). The decline reversed back to the upside after spending significant time shifting the slope of the 18-month MA line back up in early 2017 (second shaded area).  The act of turning this monthly line is time consuming and often provides plenty of time to monitor while this process takes place.  In this example, it took nearly a year to turn from the point that rallied up to it for the first time in 2016. Note that when this line turned higher, it became nice support on two deep pullbacks during 2018.

Simple Ways to Define the Trend

Simple Ways to Define the Trend

The goal of investing is to find low-risk, high reward entries.  Granted, managing and exiting positions are extremely important skills as well.  However, a good entry makes the process much easier.  The first step in this process is to identify the trend of the stock or market you are thinking of buying.  I have touched on the use of moving averages as a way of defining trend.  However, there are many methods to achieve similar feedback. 

I have been influenced by several great traders and teachers, including W.D. Gann, Victor Sperandeo, Linda Raschke, Dave Landry, Kevin Haggerty and Stan Weinstein.  Each of these market professionals agrees that PRICE is the ultimate factor that determines if stock is in an uptrend, downtrend, or transition.

Google Inc (GOOG) Daily

The chart of Google shows price only. It is clear based on this chart that GOOG is currently in an uptrend. The stock is moving from the lower left side of the page to the upper right and it is making higher price peaks and higher price valleys. It is best to keep technical analysis simple.  I have been telling clients for years that PRICE and VOLUME studies are the foundation to good technical analysis.  Before one starts to study indicators, I recommend first becoming an expert on price and volume.

In today’s computerized world, many of the software programs can be programmed to identify price trends assuming one knows how to do it. As described earlier, moving averages work very well for this purpose. I have drawn trendlines on tens of thousands of charts over the years and I still do. However, the proper use of moving averages can save a lot of time in this regard and reduce much of the ambiguity.

Another way of seeing and defining the trend is with the use of swings or waves.  W.D. Gann referred to these reversals as swings.  In the 1970’s, Art Merrill wrote a book about this concept and referred to the changes in direction as filtered waves. Many software programs call this indicator a Zigzag.

Above, the chart of Apple Inc. shows a 4% filtered wave overlaid onto the price chart.  A filtered wave means that all movement which is less than the filter is ignored.  In this case, any pullback of less than 4% does not create a wave.  Notice during 2009 this stock made higher bottoms based on a 4% filter. Using this filtered wave theory (Art Merrill, Filtered Waves- Basic Theory), one can quickly ascertain the direction as well as the longevity of the trend of a given market.

Here is the same time period as the previous chart.  However, this chart of Apple Inc. (AAPL) has our 2 simple moving averages, the 18-day moving average and the 40-day moving average. Notice that in February the 18-day MA crossed over the 40-day MA and remained above for the entire year. This reflects the same positive feedback that we just discussed with a 4% filtered wave. These are two very different approaches to defining a trend, but both are very simple and the resulting signals are virtually identical in this case. 

Why an 18 and a 40 MA? Why not a 20 and a 50 MA? Or exponential moving average?  What about the 200-day MA? (one of the most widely used MA lines). These are valid questions. Using a 20 and 50 instead of 18 and 40 would work fine. Frankly the difference between an 18 MA and a 20 MA is quite negligible. Put both on a chart at the same time and you will see what I mean. I favor the 18 MA simply because the slope shift is a little quicker than the popular 20 MA. In addition, for this method of using 2 moving averages together like a buddy system, I have found the simple MA lines to be more useful then the Exponential version.  Again, it is a personal thing and the use of EMA’s (lines which give more weight to the most recent closes in a sequence rather than weighting them all equally like the simple average) can be employed with success but you will probably need to adjust the length to make the signals a little more comparable. 

In my opinion, moving averages should not be used as an exact science. In fact, technical analysis in general, while having various quantitative benefits, is probably best when not used as an exact science either. The question of the 200-day MA is easy to answer. If we display a weekly chart with 18 and 40 MA’s, the 200-day MA is shown in the form of the 40-week MA. I prefer to use multiple time frames in my analysis because it has proven to be very helpful in refining my stock selection and timing process.  Having the ability to look at each individual time frame and its own structure, price action and momentum is useful information when trying to find key inflection points.  This will become clearer as I give more examples throughout the text.  Also, I will show why I use the 40 MA together with the 18 MA in future articles.

A Chart is a Chart

A Chart is a Chart

The goal of technical analysis, first, is to define the trend.  I will show a few different methods for defining the trend in the coming pages.  There are countless ways to define a trend but, in my view, keeping it as simple as possible should be the number one goal. 

The second goal is to determine the strength of the trend.  The strength of the trend is defined by its momentum.  In other articles, I show a few different ways to determine the strength of a stock’s trend.  The momentum of a stock can be determined by comparing the most recent price legs, or by using momentum indicators such as MACD, ADX or RSI. 

The final goal is to ascertain how long the trend has been in place.  Knowing the length of the trend is vital because the longer a trend lasts, the higher the probability for a significant correction or a reversal to take place. Below is a stock chart.  I have erased the name, dates and time frames from the chart.  This is just a set of open, high, low, close bars and a simple 18 moving average (magenta) along with a simple 40 moving average (blue).  An 18 simple moving average (MA) takes the last 18 closing prices, adds them together and divides by 18.  When plotted each day, we get a smoothed history of the closing prices over time.  A simple 40 moving average (MA) is plotted the same way only using the past 40 closes in the calculation.  Most investors that have read anything about moving averages are familiar with moving average crossover signals.  Simply put, a crossover signal takes place when the 18 MA line crosses above or below the 40 MA line.  These crossovers can be helpful in defining the trend of the stock.  In addition, the slope of these MA lines, rising or falling, and the degree to which they are rising or falling also help with determining the strength of the trend.  Regardless of whether these bars have developed over minutes or years, the pattern should be read the same way.  Identifiable patterns take place whether these bars are hourly, daily, weekly, or monthly.   The three arrows show where a crossover occurs AND the slope of the MA lines are in agreement with the crossover signal.  This is where the trend is defined as positive or negative based on these parameters.

The slope of the moving averages (18 and 40 MA) and the price structure will change if I switch from a daily chart to a weekly chart, but the process of analysis is identical.

When evaluating a stock chart, the investor must know his or her own risk tolerance in order to determine what time frame is suitable.  Generally, the longer the time frame, the larger the initial risk taken in each investment.   However, the degree of accuracy typically improves.  While minor swings may be manipulated at times, the long-term trend cannot be altered.

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