Novice Traders' Notebook  |  NOV 1997

On Moving Averages by John Sweeney

It's been around forever, and it's a tried-and-true favorite. It's also the source of great frustration. How can anything end up as both? Here are the basics for using moving averages to identify the trend in the market. No technique is more frequently used — or more maligned — than moving averages of prices. It’s used frequently because it’s the embodiment of a fundamental trading rule: Go with, not against, changing prices. Averages can’t help themselves; they always go in the proper direction, not sooner but later. Hence, the malignment: Since averages’ movement lagsÝ price action, their indica-tions for trading will be late and perhaps, therefore, unprof-itable. How to make the most of these artificial constructs? SOMETHING RELIABLE First off, in contrast to, say, trendlines, it is important to recognize that averages are a mathematical construct. There-fore, they will be computed with robotic catatonia, no matter what the current hysteria. While trendlines, arcs and circles are usually personal visual constructs, it is their mathematical abstraction that gives indicators their attraction and validity. Though an indicator can be thrown by data quirks that a human might — might! — ignore, the good side to this unquestioning use of data is that the indicator ignores noth-ing, an error that humans, prone to ignoring bad news anyway, routinely commit.

by John Sweeney