Wednesday, February 13, 2013

Moving averages Q&A

Question: “Some time ago I purchased your book, Moving Averages Simplified, personally signed by you.  I have a question in relation to moving averages and I wonder if you could help with the interpretation of my question and provide some insight.

“The moving averages I trade with are the 5- & 8-day simple MAs and the 20- & 40-day exponential MAs.

“I can’t seem to determine from my charts whether price penetrates a moving average or retraces back to it without penetrating it, because I seeing both penetration and non-penetration.  I would be grateful from your experience if you could help me.”

Answer: I wouldn’t worry about whether or not the price line penetrates above and below the moving averages -- at least not in the initial stages of a trade.  Volatility, within certain limits, is only natural in a stock or commodity and you have to expect that the moving averages will be at least temporarily violated from time to time without actually reversing the trend.  

What’s important is to find the nearest pivotal low and use that as your stop-loss guide.  Don’t worry about using the moving average as a stop-loss at all time -- just find the nearest pivotal low and use that as a basis for whether or not to stay in the trade.  

In the chart of the S&P 500 Index (SPX) shown below you’ll see that if you entered the market in late November based on the close above the 15-day moving average, you could use the November 28 pivotal intraday low of 1,385 as the initial stop loss.  Since that level was never violated you would have stayed long the market until now.  This would have been a much more reliable guide than the 15-day MA itself in terms of a stop loss.  

Bottom line: look for the nearest pivotal low when it comes to stop-loss placement and don’t worry about moving average penetrations, especially in a momentum market.

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