A Closer Look at the Trend Indicators
Over the past few years, technical analysis has expanded significantly with improvements in technology. With a few clicks of the mouse, traders have the luxury of viewing real time charts and performing detailed analysis on their computer screens. In a time when people are paying hefty fees for expensive charting software, MG Financial Group continues to offer its trading clients some of the most valuable and popular technical indicators for free in its comprehensive
Charts & News software.
The indicators offered by MG can be divided into two main groups:
Trend Indicators and
Oscillator Indicators.
Trend indicators aim to predict the general market direction using various tools like price patterns, support & resistance levels, trendlines, and moving averages.
Oscillators used in conjunction with trend indicators can greatly benefit traders by highlighting short-term market extremes, commonly referred to as overbought and oversold conditions. We will take this opportunity to discuss the application of the trend indicators in detail.
Moving Averages:
Moving Averages are considered by many technical analysts to be the most important trend indicators. Moving averages were touched upon briefly in
Charting Application Tutorial and, as we continue that discussion, we will, more importantly, elaborate on the application of moving averages. The Moving Average is a lagging indicator that shows the average value of a currency's price progressing over a certain time period. There are three different kinds of moving averages:
Simple,
Weighted, and
Exponential. Moving averages can be calculated on any data series including a currency's open, high, low, close, or other, and MG's
Charting Application chooses to use the closing prices.
The
Simple moving average is basically the arithmetic mean of the most recent prices for a particular time period. For example, adding the five most recent day's prices and dividing that sum by five will obtain the 5-day moving average. The only significant difference between the various types of moving averages is the weight assigned to the most recent data.
Exponential and
weighted averages apply more weight to recent prices.
Keep in mind there are no hard and fast rules but many traders make use of one or more moving averages at the same time. In his book,
Technical Analysis Applications in the Global Currency Markets, Cornelius Luca recommends using the 4-9-15 days for the very short term, and 5-20-60 and 7-21-90 for medium or the long term. As expected, the sort of interval you choose should depend on the time frame for your trading strategy.
There are two popular methods that analysts use for incorporating moving averages:
The 1)
Double Crossover Method and the 2)
Triple Crossover Method
The
Double Crossover Method uses two moving averages. A buy signal occurs when the faster of the two averages crosses the slower one and moves upwards. When the faster average crosses the slower one and moves downward, it is treated as a sell signal.
Note: a faster average represents a shorter time interval while a slower average indicates a longer-time interval.
In the graph above, the red line is the 20-day moving average and the pink line depicts the 5-day moving average. A
BUY signal is triggered when the short-term moving average (5-day) crosses the long-term average (20-day) and moves up afterwards. Later in the chart, the 5-day average intersects with the 20-day average again but moves down afterwards, suggesting a
SELL opportunity.
The
Triple Crossover Method involves three moving averages. This is a two step method and it generates a warning signal that precedes the trade signal. The intersection of the faster averages generates a warning signal and the intersection of the slower averages following the initial intersection of the faster ones gives traders the signal to trade.
In the circle marked A, the 4-day moving average represented by the green line crosses the 9-day average, shown in pink, and subsequently intersects the 18-day average, shown in red, and then continues upwards. This is a warning signal to buy. The actual signal to buy is generated when the two slower averages, the 9-day and 18-day averages, cross each other.
As you can see in circle marked B, the 4-day average intersects both the 9 and the 18-day averages and moves downwards, producing a warning signal to sell. It's only when the 9-day intersects the 18-day average that a sell signal is produced. Jim Chorek points out in his forum discussion that he likes using crossover methods but the timeframe and the kind of moving averages chosen depends on the type of currency market.
Moving averages are easy to use and they notify traders of several entry and exit opportunities in the market. However, it is important to remember that these methods are not always on target and may sometimes generate false breaks.
Bollinger Bands:
This is another important trend indicator offered by MG's
Charts and News software. Bollinger Bands surround the movements of the currency by forming two bands situated exactly at two Standard Deviations from the moving average. Many chartists will agree that one standard deviation is usually 20 days. The upper band is two deviations above the moving average and the lower band is two deviations below it.
Bollinger Bands are very useful in serving as price targets. If the price rebounds off the lower band and moves above the 20-day average, the upper band becomes the upper price target. A crossing below the 20-day average would make the lower band the downside target.
In the figure above, after the currency crosses below the 20-day moving average, shown in red, the lower band serves as the price target on the downside. Each of the green circles around the lower bands reflects a market bottom and could have served as a good buying opportunity.
Oscillators combined with trend indicators present useful insights and can aid traders in making better trading decisions. MG offers numerous oscillator indicators in its
Charts and News software to complement the trend analysis discussed in this Tip. We intend to feature Oscillator indicators in detail in a future Tip of the Month.
References:
· Luca,
Technical Analysis Applications in the Global Currency Markets, 1997
· Murphy,
Technical Analysis of the Financial markets, 1999
These articles are designed to help traders understand the unique benefits of trading with DealStation. Articles contain hypothetical examples that have been created for illustration purposes only.
The opinion of the writer does not necessarily represent the view of MG and must be considered as an opinion and not fact.
