Another issue that I was thinking of recently was when using moving averages (MAs), which is more important? The slope? or the crossover condition (i.e. is price above or below the MA)?
The recent book I reviewed from Anne-Marie Baiynd showed that she uses the slope. Barry Burns uses the slope (especially with his rubber band trade). Steven Primo uses the position of the price relative to the MA (i.e. his buy/sell line).
So what should we be looking at? Let’s drill down.
Slope of MA
The slope, or angle of a MA is influenced by the substitution of bars in the MA calculation. The slope turns down where there is a substitution of a cluster of higher prices for a cluster of lower prices (within the MA length), which is a bearish sign. The reverse for when the angle turns up.
Note that while the angle may be shifting because of the substitution, the level of the MA might remain around the same. For example if price started with a cluster of high prices, plunged down, and recovered 50% and stayed there for a while. The angle would be down because of there is the substitution of a initial cluster of high prices, with the eventual cluster of ‘middle’ prices. However, price might be above the MA and the level of the MA might remain rather flat.
Level of MA
The level of a MA is just an average of recent prices. If price is below the MA, it means that compared to its recent history, it is down, so that implies a higher probability of going down further.
Combining Both Slope and Level
Both the angle and the level of a MA provide clues. Ideally you want both to be aligned, but often times they are not.
When the angle is down but the price is above MA, usually this implies
- Price has very recently moved above the average price per the MA length
- However the angle is down because price
- Has not been above the MA high enough; or
- Has not been above the MA or moving up long enough (time-wise) such that the prices on the left of the MA calculation (that are being substituted with recent prices) are lower than the recent prices (so as to produce an upward sloping MA).
So while prices being above the recent average is good, because there is no strong upmove (i.e. strong as in moved up a lot in distance) and/or the turn from down to up only happened recently (recent as defined by the MA length), it may not be so clear that the trend has indeed changed.
Matching the Required Conditions to the Trade Type
A more conservative approach here would be to wait for the MA to be angled up before taking a long trade. This is where a distinction has to made been a trend change entry versus a trend retracement entry.
A trend retracement entry is a conservative entry because the trend is extremely clear to all market participants, In this case we want both the slope and the price relative to the MA, to be in the direction of the trade.
A trend change entry however is more aggressive because you are going in when it seems likely that the trend has changed, but it is not yet extremely clear to everyone. In that scenario, you would not be able to take a conservative approach and wait for both the slope and level to be aligned. In fact, from trading experience, most of the time, the price action would show the trend change first, while both the slope and the level are not in agreement with the trade direction. So to take such a trade, we just need confirmation from the price action, and price to be in close proximity to the MA, such that we think it is likely for both the MA slope and level to be in line with the trade direction fairly quickly.
- Trend change entries just needs price action confirmation and proximity to the trend MA.
- Trend retracement entries require both MA slope and level to agree with the trade direction
- A price crossover is easier to achieve compared to a slope change, hence it is not as significant as a slope change. Hence price crossovers tend to happen earlier than a slope change.