PR16 - Using moving averages to determine the price trend

"Moving averages are one of the oldest and commonly used technical indicators. This indicator is used as a trend determination indicator. The moving average allows traders to understand the price, based off technical analysis which uses indicators. There are a number of ways to gauge the trend in the markets. Therefore, you will find traders making use of different methods by applying the moving averages to the price. In this article, you will learn three ways on how to determine the trend in the markets using the moving average indicators. The methods outlined in this article will enable traders to either build up on their technical signals or build a completely new trading system by itself. In the previous section we covered the different types of moving averages. Learn how you can make use of these different moving averages to understand whether price of a security is in an uptrend or in a downtrend."

Moving averages are one of the simplest of all technical indicators. It is widely used in the determination of trends. As someone trading with technical analysis, it is essential that traders understand how the trend can be determined by using trends.

There are a number of ways to do this. For example, some traders simply make use of just one moving average, while others make use of two or more moving averages. Regardless of the number of such indicators that are used, the understanding is basically the same.

Trend determination using triple moving averages

Triple moving averages are commonly used in a way to not only determine trends but also short term correction in price. The general rule of thumb is that there are three moving averages of different lookback periods. The typical setting is usually 200-day, 100-day and 50-day moving average.

In this scenario, when the two short term moving averages cross over one another, it signals that the markets are in a strong trend. Likewise, when the two short term moving averages cross below the long term moving average, it signals that the markets are in a downtrend.

Within the trends, you might see a medium term and short term moving average crossover while staying above or below the longer term moving average. These scenarios simply indicate when the markets are correcting within the trend.

The three difference moving averages allow traders to trade in the long term and also helps them to determine when the markets are correcting within the trend.

The chart below illustrates the three moving averages on a price chart.

PR16 01 Triple Moving Average

Triple moving average method to determine trend


Trend determination using two moving averages

In this method, traders use two moving averages to understand the trends. A long term and a short term moving averages are used. Typical settings include a 200-day moving average and a 50-day moving average for example.

When the short term moving average crosses above or below the long term moving average, an uptrend or a downtrend is signaled. In technical jargon, these crossovers are also known as the golden cross and the death cross (bullish and bearish).

Based on the crossovers, traders understand whether the trend is up or down. However, one of the drawbacks of using two moving averages is that they can lag quite a bit. This is because moving averages are lagging in nature.

Thus, the uptrend and the downtrend that is signaled by the moving averages tend to be lagging in nature. In many cases, the bullish and the bearish signals are formed much after the trends are determined.

The chart below shows the two moving averages on a price chart

PR16 02 Double Moving Average

Double moving average method to determine trend


Trend determination using one moving average.

Traders can make use of just one moving average in order to determine the trend. This is a bit more complex compared to the other types mentioned earlier. With just one moving average, traders look at price in relation to the moving average in order to understand the trend.

The most common moving average period that is used is the 200-day moving average. Depending on the time frame, other lookback periods include a 50-day or a 100-day moving average as well.

The requirement to make use of an exponential, simple, linear weighted or smoothed moving average is up to one’s discretion.

When using a single moving average, traders use the price in the context of the moving average. For example, when price is trading consistently above the single moving average, it can indicate an uptrend.

Likewise, when the price is consistently moving below the single moving average, it can signal a downtrend.

The price crossover off the moving average is often seen as a bullish or a bearish signal in the price trend.

The chart below shows a single moving average and how price reacts to this in determining the tends on the chart.

PR16 03 Single Moving Average

Trend determination with single moving average


Besides the above three types of moving average methods to determine the trends, traders also employ their own versions. For example, the rainbow moving average is commonly used as a way to understand the strong trends.

By using five or more moving averages with different lookback periods, these rainbow moving averages signal not just the trend but also the divergences that are formed. Traders should remember that regardless of whether they use just one moving average or three or five, they signal the same market information.

For traders, the moving averages are a great way to understand the trends in the markets. These technical indicators can be used in conjunction with other technical indicators such as oscillators as well as volatility bands.

Read 868 times Last modified on Sunday, 14 July 2019 08:55