Most traders are familiar with moving averages. They are a useful technical tool for identifying the direction and strength of a trend. However, most traders overlook a very useful characteristic of price that allows us to identify a trading opportunity using moving averages. That characteristic is elasticity.
Prices are elastic. They will move away from an average and then snap back. They repeat this process in a trend over and over, stretching away from that average before returning. In a trend, however, the average will slowly move in the direction of the trend thus making the price cover less distance when retracing.
Imagine a rubber band. If you stretch the band slightly, it will snap back to its original shape. If you stretch the band further, you will have a more violent snap back to the original shape. Price acts in a similar manner. If you observe price stretching away from an average, it will snap back as soon as it strikes a level of supply or demand. Stretch price further, such as a parabolic move, and you will often experience a stronger return.
In the following chart, I have used two moving averages to demonstrate this effect. The blue is a short period moving average to observe the short-term trend. The pink line is a longer period average to mark the larger trend. Now you’re probably wondering which moving averages I used, right? Sorry, that information is reserved for my students in the Online Trading Academy classes and the Extended Learning Track program. It wouldn’t be fair to them for me to share. However, you can join us there and share in the knowledge.
Note how price will move away from the average and then return after reaching extremes. We can locate high probability long and short entries when this is combined with supply and demand studies. In the chart, I identified a shorting opportunity when we reached a supply level coupled with a bounce off of the longer term moving average.
Learning to read price and its relationship to averages is a valuable skill that can be used in trading any market. Whether you trade stocks, Forex, or futures, reading price relationships is how traders profit. Learn this valuable skill from our professional traders/instructors at an Online Trading Academy center near you and then when you are a graduate, log into our virtual classroom from your home in the Extended Learning Track program.