Lessons from the Pros


Move Away

Moving averages are an average of closing prices over a period of time.  Many traders try to use them as a dynamic trend line.  The price of any security is elastic and will stretch away from the moving average during impulsive moves with the trend and then will snap back to the average when correcting.  While most traders focus on the bounce from the moving average, the distance that price moves from the average in an impulse, may offer clues to the strength of the trend.

When prices continue to move further away from the average on every impulse, it suggests that the trend is strong and is likely to continue.  However when the bounces from the average are smaller, this could be a sign of weakness and potential reversal coming if price is also approaching supply or demand.

In the following example, the SPY has been using an upward sloping 20 period exponential moving average as a bullish trend line.  When the price fails to bounce higher from a test of the average, it usually precedes a break of that trend.

bwendell 20120821 - spy ma move

A trader looking at the chart of CERN in a downtrend would benefit from watching the movement away from the moving average.  When price fails to bounce to new lows after testing a downward sloping moving average, it usually signals a reversal in the trend.

Traders should remember that this is only to be used as an odds enhancer and that prices will reverse at strong supply and demand levels regardless of the movement from a moving average.  However, if you are trying to determine whether to buy or sell at a particular supply or demand level, taking note of the strength of the trend can be beneficial.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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