Novice Traders' Notebook  |  DEC 1998

Trends And Moving Averages by Robert Nikifork

How do you choose which length and type of moving average to use for chart analysis? Take a look. One commonly used technical indicator is the moving average (MA), which is plotted as a line connecting the average of closing prices over a lookback period. Moving averages may be used as trend indicators and to identify support and resistance levels and breakouts. The major complaint concerning moving averages is that they lag changes in the trend and thus lead to late signals. Because of that flaw and their widespread use, many articles have been written about moving averages. In most of these articles, the writers discuss exotic forms of moving averages that they feel are superior to the more common forms because they reduce the lag or follow the trend closer. Some common suggestions are methods to add an exponential factor to the moving averages, weighting recent closing prices more heavily, and using more than one moving average. For mechanical trading systems, the length and type of moving average chosen may be significant if it is backtested and proved that, for example, a break above an x-length MA has generated larger profits and smaller drawdowns than other lengths; in such an instance, it may make sense to choose one moving average length and type. But many traders do not trade systems based on moving averages, while there are others who use them only as guidelines in making decisions about when to buy and sell. In such a case, how should a trader choose a moving average length? With respect to simple MAs, many lengths are popular among traders, including but not limited to 10, 20, 21, 30, 50, and 200 days. But why would these be any better than, for example, 16, 24, 77, or 136? The obvious answer is that we prefer round numbers, but is there any reason why a round number would offer a trader more insightful information than any randomly chosen number?

by Robert Nikifork