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Trend Indication

Moving averages are a useful trading tool when used properly. As long as you realize that they are a trend following, lagging indicator and do not base your entries solely on them, you can use them to assist you in weighing trading decisions. In our Professional Trader Course and Extended Learning Tracks, I teach using moving averages as a way to plan trailing stops, to find probable entry areas, and to help confirm entries and exits to trades at supply and demand.

Most traders use the closing price when calculating moving averages. That is because we assume that the closing price is the most important. We want to know the consensus of the battle between bulls and bears for the time period we are looking at. Who won? Were the buyers or sellers more dominant? The closing price also gives us the final shape of the candle and clues to the strength of the trend.

The relationship between the open and closing price for a period can be important as well. In a strong bullish trend, the closes should not just be above the opening price but well above. If the closes are not as far away from the open as they were before, the trend may be weakening. In a bearish trend, you would expect that the closes would be much lower than the opens in order to show strong selling pressure. If this is not the case, your trend may be weakening.

If we use two moving averages, one set to the open, and another on the close, we can get a lot of information about the trend. Both averages need to be the same length, (i.e. – 20EMA), but one input is the opening price and the other is the closing price for the period. Watch to see the spacing between the two lines. If it is increasing, then the trend is likely strengthening.

bwendell 20120313 - ma-widening
Figure 1

If it is narrowing then the trend is weakening and is likely to reverse.

bwendell 20120313 - ma-narrowing
Figure 2

You can use this to judge the strength of any trend and in any time frame. Just remember that it is lagging slightly due to the nature of moving averages. You can speed up the indicator by using a smaller number for the inputs but you will get more false signals that way. It is best to experiment with settings to see which works best for your security and trading style.

This can also be used as a filter to keep you on the right side of the trend for your trades. If the close average is above the open average, only initiate long trades.

bwendell 20120313 - ma-longs-only
Figure 3

Once the close average has dropped below the open average, then you would only want to trade on the short side for higher probability.

bwendell 20120313 - ma-short-only
Figure 4

Try this indicator out if you want and see if it helps you to identify the trend and strength of that trend. Still base your trading decisions on supply and demand though. That is your one leading indicator along with price.

Have a great day.

Brandon Wendell

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.