Combining Guppy Averages With A Winning Trading System

08/20/10 08:27:20 AM

by Donald W. Pendergast, Jr.

Filtering your trading system's output with Guppy moving averages can help keep you on the right side of most major market moves.

Security: RTN
Position: N/A

MetaStock 11 comes preloaded with a Guppy moving average template, and it's one that serious traders would do well to familiarize themselves with. I've combined the Guppy averages with some of the Rahul Mohindar (RMO) trading system components into one easy to use template, one that even new traders can use to do a little selective filtering of any given trading system's signal output. Here's a look at some of the advantages of combining both powerful trading tools.

FIGURE 1: RTN, DAILY. Trading with the trend is a popular expression. With the Guppy moving averages, you have an objective technical means by which to determine the primary trend in any given time frame. The trend in RTN is still down, but the looming support level near $45 makes the current RMO swing sell signal less appealing.

Graphic provided by: MetaStock.

Graphic provided by: Rahul Mohindar (RMO) and WB ProfitTrader.

Figure 1 is a daily chart for Raytheon (RTN) on which two of the RMO trading tools (ribbon and the long/short swing trade signals) are overlaid along with the Guppy moving averages and the WB detrend RT oscillator. Using all three in a thoughtful way can help give you more confidence when a low-risk trade setup appears (see the setups within the two rectangles on the chart) as well as help you steer clear of setups that have a poor risk to reward ratio (see blue oval on chart).

Now, we all know that you're not supposed to cherry-pick trade system signals, and for the most part that is sound advice, assuming you've got a proven, backtestable system that produces a steadily rising equity curve. However, at this time, MetaStock does not provide a way to objectively backtest the RMO swing trading signals, meaning that traders who use the standard version of the system that comes out of the box are left to determine how to decide which signals are preferable in a given situation. Guppy moving averages may be just what we need to filter out all of the countertrend signals, keeping us safely on the right side of the dominant market trend.

This article is not the place to provide an exhaustive tutorial on the use of the Guppy moving averages, but here's the big idea:

The long-term set of exponential averages, set at 60, 50, 45, 40, 35, and 30 periods, are meant to provide a means of determining the long-term trend for any given time frame. When you see the spread between the averages are both wide/widening and straight, you can safely assume that a strong trend is in effect. In such a case, a wise trader will wait to enter a position when both the tradable in question and its short-term set of exponential averages (set at 15, 12, 10, 5, and 3) pull back toward the longer-term set of averages, just like we see in the setups highlighted in the rectangular boxes. Then, when the market makes a new move in the direction of the original trend, the trader can use his or her preferred mode to time a new long or short entry. In this case, I'm using the RMO swing trade signals, but you can use any trading system you like, simply filtering the output through the Guppy moving averages.

If you look at the most recent RMO swing trade sell signal (blue oval), you'll observe several things that are different from the two previously highlighted:

1) The signal comes after only a shallow pullback to the top of a small consolidation range.

2) The signal arrives after a long, sustained downtrend has already occurred -- and far away from the longer-term set of averages.

3) The signal arrives even as a minor bullish divergence between the WB detrend oscillator and price has begun to become very obvious.

4) The signal also occurs just above a major area of support, that being the major October 2009 low at $45.02.

Do these four negatives points mean that this is an invalid short trade signal? Not at all, but the probabilities for a winning trade are less than they were when the other two featured setups originally appeared. And since this is a de facto discretionary method, it only pays to use a little common sense and wait for a more favorable setup, perhaps one in another stock that is exhibiting some of the more desirable characteristics that were mentioned earlier.

Try the Guppy moving averages in your own charting software and see if they don't help you get a much better handle on the primary trend of the markets you regularly follow. It will be time well spent.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title:	Writer, market consultant
Company:	Linear Trading Systems LLC
	Jacksonville, FL 32217
Phone # for sales:	904-239-9564
E-mail address:	lineartradingsys@gmail.com
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Combining Guppy Averages With A Winning Trading System

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