Moving Averages - A Picture

Is worth a thousand words. Below is the view the pro's use to keep an eye on the health of the market. It isn't publicized much because 10, 20, 50, 200 period simple moving averages are what fill the books.

Very few older books even mentioned exponential moving averages and then it was an oh-by-the-way throwaway line. In fact I didn't use them much myself until I read Martin Schwartz's book, "Pit Bull". I don't know if you know about Marty but you should - he is a champion trader - and not self-certified like Jimmy Crack Corn Pone. If you haven't read his book - what are you waiting for? Marty is a bit of an arrogant boy-o (like me) but the book is worth reading.

I can't find the exact quote right now but Marty used exponential moving averages in his trading. And he made it seem like they were the right way to do things. (He also used Landry's "T" but that might be a subject for a future post). After I read his book back in 2000 I started seeing the EMA for its value to my trading.

Here is the DIA in a 5-year weekly view with a 90-period EMA and a 200-period SMA - which moving average best reflects the support levels of the DIA? (Hint - the EMA is the "blue" one).



To drive home the lesson - here is the SPY 5-year weekly view with a 90-period EMA and a 200-period SMA - which moving average best reflects the support levels of the SPY?



Tell me which moving average would the SPY fall through first if it were going down? Which one would it go through first if it were going up? Don't you want to be first?

Of course, you say, but what about the 50-period SMA? Here is the SPY with the 50-period SMA? Which average best describes resistance?



But there is another point I'd like to make regarding these two averages. I'd like you to look at this charts very closely and you will notice that back in '03 it ran well away from the SMA 50 but only came back in when it got away from the EMA 90. You can see that between Jul and the following April the 50 was rising to catch up with the price and in fact crossed over the EMA 90 in its effort. But the market turned down in early 04 even though the 50 was rising to meet it. I think, just based on the geometry of the chart, price was seeking the EMA 90.

I personally believe that people who ignore the EMA and use MA's leave money on the table. But it is your money and your choice - try them both and find the best and most trusted method for you.

I use the EMA 90, EMA 21, EMA 8, and EMA 8 in my trading in all time frames. I seldom even look at an SMA except for testing purposes. If I find a good filter using SMA I guarantee I will publish it.

Are You Still Using Simple Moving Averages?

If so - why - because everybody else does?

I know some things still require you to use SMA such as Bollinger Band due to its dependency on standard deviation calculations that use the SMA but if you have no real need to do so why are you doing it? People who use the simple moving average are giving money away. And, as always when I make a broad statement like that - unlike Jimmy Crack Corn Pone - I can prove it.

I built a filter that is based on the EMA 21. Then I cloned that filter and changed two lines to base it on the SMA 20, a very popular SMA. Here is the EMA 21 Filter

show stocks where close is between 15 and 35
and average volume(90) > 500000
and close > open
and close 1 day ago > open 1 day ago
and close > close 1 day ago
and close 1 day ago > ema(21) 1 day ago
and low 1 day ago < ema(21) 1 day ago

The other filter was exactly the same except ema(21) is changed to sma(20) in both lines shown.

and close 1 day ago > ma(20) 1 day ago
and low 1 day ago < ma(20) 1 day ago

The filters were back tested with everything held equal and here are the results:

EMA 21 = 61% Win Rate, 1.53 Risk/Reward, and 86% ROI.
MA 20 = 50% Win Rate, .93 Risk/Reward, and -7% ROI.

So just looking at those two results sets, which type of moving average do you think you should use? Just a thought - not actionable - unless you want to stop giving away money.

Swing Trade - 4

In this one I combined the SMA 200 with the SMA 20 in several variations.

If the Close is:
< 200 > 20 27871
< 200 < 20 4308

> 200 > 20 19994
> 200 < 20 12393

Again this is for 1 trade a day, no more than 4 stocks in the portfolio at any one time, and the holding (swing) period is at least 1 day but no more than 4 days.

The filter requirements are exactly the same as those in Swing Trade - 3.

The obvious winner, again, is when the close is less than the 200 period moving average and less than the 20 day moving average.

If you do decide to use exponential moving averages you are probably going to be a little bit ahead of the average trader - by this I mean the exponential should get you into the trade before the other guy and that is a good thing. It will also get you out before him too and that, sometimes, is even a better thing.

None of these posts are recommendations - do your own due dilligence. Betting, uh, playing, uh, "investing" (wink wink nudge nudge) in the stock market is not as easy as it looks. Trust me - I've got the scars to prove it.