Moving Averages at Trade10.com- The science of trading market momentum for stocks, options, futures and bonds.

Critical Day Analysis

Our critical day analysis is all about trend reversals. We tell you when there is a high potential for a reversal of the short trend and we've been doing it since 1994 with an 80%* accuracy.

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Moving Averages

Moving averages are used to help identify the trend of prices. By creating an average of prices, that "moves" with the addition of new data, the price action on the security being analyzed is "smoothed". In other words, by calculating the average value of a underlying security or indicator, day to day fluctuations are reduced in importance and what remains is a stronger indication of the trend of prices over the period being analyzed. The term "Moving" refers to the method of calculation which takes the average value over a fixed period of time and adds the latest period data to the calculation of the average while dropping the first period of the calculation so that the average continues to be calculated by the same number of periods but moves with each new period of data that occurs. Thus the average "moves" along with price and changes in value as price data is generated. An 18 day moving average represents the trend in prices over a period of 18 days. A longer 50 day moving average is smoothed more than an 18 day moving average with each new day's data making less impact on the calculation of the moving average value than a shorter term moving average such as the 18 day moving average. A longer term moving average such as the 200 day moving average is plotted to identify longer term trends in price. A basic approach to using moving averages is to identify which term of price trend you wish to monitor and produce an appropriate period moving average. In this approach, while price is above the moving average it is an indication of bullish behavior. While prices is below the moving average it is an indication of bearish behavior in relation to the trend length being viewed. When price falls from above the moving average to below the moving average it warns that the price trend being viewed may be weakening. When price rises from below the moving average to above the moving average, it is a bullish indication of the price trend length under scrutiny. The shorter the term of a moving average, the more susceptible these signals are to whipsaws. Since a moving average is a lagging indicator of price trend, there is a trade off between timeliness of a signal of bias change in the price trend being analyzed and the reduction of the possibility of whipsaw. A second approach is to plot two or more moving averages and look for crossover points to help identify periods of significant change in underlying bias for the tradable security. When a shorter term moving average crosses from below to above a longer period moving average it is a sign of bullish bias. When a shorter term moving average crosses from above to below a longer period moving average it is a sign that a bearish bias is present in price trend development.

There are a number of different types of moving averages that have been developed by technical analysts in the study of trends for use with price and indicators. A moving average can be arithmetic which is the sum of the closing prices over a certain number of time periods divided by the number of time periods to get an average price of the security for that period. An exponential moving average (EMA) is calculated by adding a percentage of yesterday's moving average to a percentage of today's closing value. In this way an investor can put more emphasis on more recent data and less weight on past data in the calculation of the moving average. Other types of moving average calculations include time series moving average, triangular moving average, variable moving average, volume adjusted moving average and weighted moving average. In addition to the variations in calculations, investors can also shift a moving average horizontally or vertically on a graph and base the calculation on the open, close, high, low, or average price rather than the close. The most commonly used moving average is the exponential moving average based on closing prices without any shift. The value of knowing the most commonly used moving average lies in the fact that signals may influence a larger group of investors and therefore become more significant as response unfolds in the marketplace.

Moving Average Interpretation

The basis of interpretation is to buy when the securities price moves above its moving average and to sell when the price moves below its moving average. Different lengths of averages are meant to identify different trends. Short trends are often best identified by a 5 to 13 day moving average. Minor intermediate trends are roughly 25 to 50 days. Intermediate trends from 50 days to 100 days and long term trends greater than 100 days. The length of the moving average should match the cycle or trend you wish to follow. When we refer to the short trend in relation to critical day analysis, we are referring to the smallest segment of price leading into and away from a critical day.

Whipsaws can be reduced by using a larger period of calculation but also results in later signals. There is a trade off between timeliness and following daily price fluctuations too closely. Traders using moving averages to help identify the trend of a tradable security should determine an appropriate trade off that reduces whipsaws but also minimizes the lateness of signals received.

Moving averages can also be used on indicators such as the Stochastic, Relative Strength Index and the Rate of Change in order to smooth daily fluctuations and reduce potential whipsaws.

Crossovers between two moving averages can provide signals for a tradable event. Back testing sensitivity is a good approach to determining appropriate averages to use. Using parallel lines to plotted moving averages leads to another application of trend analysis called channel analysis.

Plotting two moving averages can provide signals for trading when a shorter moving average crosses a longer term moving average. The trade off is between timeliness and possibility of whipsaws.

To the right technical studies are examined in more detail to provide a sense of conformational evidence for traders of the critical day. Click on any of the terms to take a closer look at a technical discussion on that topic. All formations, patterns, indicators and technical tools fail at various times and so should only be used to build a body of evidence in forming a trading decision rather than being solely relied upon. There are a number of valuable studies that lead to intuitive understandings about price and volume but a strong compliment to technical analysis is an understanding of the trends and changes in the fundamentals and economic activity that ultimately lead valuation levels in the markets.

Walk through a critical day

The graphs show a price plot of the Dow Jones Industrials from Sept 28/00 to early November. The First graph ends on November 3/00, two days before an upcoming critical day on November 7/00. Our members looking at the market are expecting a trend reversal to occur due to the high rate of success in our research. Ideally a member will be using their own skills to judge the supply and demand changes, using technical and fundamental indications to confirm suspicions of a reversal, and trade accordingly.
On the second graph we see that the price action on November 6 was a bullish day, reversing the short trend so that the short trend leading into the critical day is now up. A critical day is an expectation of a reversal of the short trend that immediately precedes the critical day. In the case of the November 7 signal, given to members 3 days before, is an indication that the upward moving trend, recognized at the close of November 6 is expected to reverse direction.
On the third graph we can see that November 7 was a low volatility after a large gain on November 6 of about 160 points for the Dow Jones Industrials. The subsequent move over the three days following the November 7 signal saw the Dow Jones Industrials fall 376 points. The next day, November 13, the Dow Jones Industrials lost an additional 83 points with intra-day low a full 609 point loss since the open on the critical day.

Most recent signals

A closer view of the most recent signals. You can see the short trend immediately prior to a successful critical day, reverses coming away from the critical day. Often a failed critical day will indicate a stronger bias in the market for continuation of the trend that was in place prior to the critical day. A failed signal can therefore provide as much information and opportunity as a successful one. Take a look at tech studies to develop a sense of trend reversals and use.