I’ve been banging on about the crucial support levels provided by long-term moving averages and asked you to trust me that they are important. Now I better tell you what they are.

The tricky bit is that most Technical Analysis books devote a very large chapter to moving averages, which tends to have a similar effect to watching Chelsea play football. I’ll try and give the free introductory offer and leave the heavy stuff for later.

How best to describe a moving average (MAV)? A support & resistance (S&R) line made of spaghetti, or one that’s had a pint or two of the black stuff. No, that’s harsh; it’s much more than just a bendy S&R line. I know, if S&R lines are a telephone land line, think of moving averages as a top of the range mobile phone- it does the same job (unless it’s got reception like Z’s), but you can get much more out of it.

The purpose of a MAV is to signal that a trend has started, stopped or reversed.
However it’s important to note that a moving average is a lagging indicator. It’s slow in identifying the beginning and end of a trend, but is damned useful in the middle as a trend guide.

“Sounds great mate. Get to the point.”

Sure. A moving average is an average of prices for a certain number of periods (the period is the ‘length’ of each candle or bar on your chart. So on a chart of the last 6 months each candle might represent a day while on a 30-minute chart a candle may represent a minute).

The moving average smoothes out prices to show a trend: the greater the number of periods the smoother the trend and the bigger the time period the more significant it is. So, in football speak, a 20-period MAV on a 10-minute chart would be the Friday night team that one of my boys plays for and a 200-day moving average would be Man United (well, last season’s Man United).

“Hold on mate, I’m nearly there, but I spent math’s lessons looking at the girl in front’s legs. How does this moving average work?”

Easy. If I’m looking at a 10 day moving average, then I’ll add together the closing price for the past 10 days and divide by 10.That would be the average price. The following day I’ll take off the price from 11 days ago and replace it with the most recent close. See. Now it’s a moving average.

Choosing a time frame is a bit like trackies or Chinos; Chelsea or Liverpool; legs or boobs. It’s a personal preference; whatever suits you best. But first you need to know what you’re going to use it for.

The free introductory offer is going to keep this simple. The ideas are straightforward, but require individual tinkering. I know that’s not a great help if you’re just starting but have a little play with the examples below on the demo account.

Using MAVs to identify trends.

Variety being the spice of life, I tend to use 4 daily MAVs as my core indicators. On my daily £$ and FTSE charts I have the long-term 50,100 and 200 day moving averages, which I use more as key support lines rather than trend lines. I’ve been boring for England about £$ testing the 200-day MAV, which is still just hanging in there.

I use a 21-day MAV as my trend guide in two ways. Firstly I look for the price to stay above the line, but secondly I want the line to continue in the direction of the trend. I take both the price crossing the MAV and a turn in the direction of the line as warning signs.

The 50-day MAV is commonly used as a trend line, but the trouble with using the 100 and 200 is that a trader will have done his conkers well before those lines are tested.

But don’t ‘dis’ the 200 MAV- as a long-term support line it’s massive. It also epitomises the fury of a woman scorned. Everything’s OK whilst the price remains above, but if it crosses the line there’s hell to pay and it’s not easy to get back into favour.

Standard S&R Principles- support becomes resistance

Just like normal S&R lines the more times the MAV is challenged and holds, the more street-cred it gains. Traders become more confident that it will hold so are more likely to support the current trend. BEWARE, it might also mean that a break below the trend is more violent due to the increased number of stops waiting to be triggered.

When a trend is in place a longer average is better for keeping you on board, but the downside is a late warning when the trend reverses. This is why many traders use a second, shorter MAV as an early warning.

Using MAVs To Signal Trades

This is really just using trend crossovers to determine when to enter a trade.
The simplest trading strategy is to use a single MAV and buy when the price crosses the MAV in an upwards direction and sell when it crosses downwards. Some traders will refine this to
1) The price must close below the line before they will trade.
2) They will wait until the MAV turns in the direction of the crossover for added confirmation.
The choice of MAVs is key; too long and the trade will be long gone, too short and you’ll be in and out like a fiddlers elbow and lucky to cover your dealing spreads.

You can see from the chart that trading the 5-period MAV (green) is pointless, but the 30-period MAV (blue) yields some good gains.

Many traders will use intraday set-ups, choosing, say, a 30 period MAV on a 30-minute chart.

The double crossover method is nothing to do with transvestite twins; it refers to the use of two MAVs to signal a trade. Instead of using the price as the trigger, the buy signal occurs when the shorter moving average crosses up through the longer MAV. A packet of nuts to the guy at the back if he can work out the sell signal.

There’s a whole ‘pick’n mix’ selection of which time periods to use; popular combinations are 5 and 20 day averages or 10 and 50 day. Some hedge funds, with all their Blue Peter black boxes and computer models, use a simple moving average crossover like the 10 day/100 day to trade currencies. Day traders will even use intra day crossovers as a signal, using, for example, 5 and 20 period crossovers on a 30-minute chart.

I must be honest here; I’ve tried quite a few combinations in the past and found the ‘time lag’ frustrating. I would watch a trade slip away whilst waiting for the *@?*@ MAV to hurry up and crossover. That’s not to say its wrong; it was probably my impatience. Give it a try on the demo account; see how it works for you.

MAVs are often combined in a trading set-up using a momentum indicator like RSI, chart patterns or good old-fashioned S&R lines as confirmation, but that’s for another coffee break.

So, what’s the current state of play on my daily £$ chart?

The top green line is the 21-day MAV; dark blue 50-day MAV; light blue 100-day MAV and bottom green the 200-day MAV.

The price broke below my green 21-day line in late July, but the confirmation was provided two weeks later when the trend line turned down. The dark blue 50-day MAV was only a temporary stopping point, the light blue 100-day MAV even less so.

But the green 200-day MAV has been doing a grand job of sticking its finger in the dyke (for anyone under 25 no, it doesn’t mean that, it’s an old story about a Dutch boy trying to save his country from the floods). At the moment, £$ has certainly broken below a few times (technically called the ‘dangly bits’) but it keeps returning above the line.

Sure, it’s a tricky time, and it might eventually break the line convincingly, but it has probably sent a few traders to explore other currencies rather than argue with the 200 MAV.

“Cheers mate, I’ve just read all this and looking at my FTSE chart, the price didn’t even stop to wipe its nose before charging through the 200 MAV.”

Bang on, and that’s a useful reminder that technical analysis doesn’t always work; it’s just about looking at different measures to give your trade more chance of succeeding. In tumultuous times like these its better to just step aside and say, “After you mate.”

Happy Trading