When trading or investing, you need to properly identify the trend that your security is in so that you can trade in the direction that offers the highest probability for profit. At Online Trading Academy, we know that there is no substitute for reading price itself. Our patented Core Strategy involves finding the trend of a security as well as many other parts to increase your chances of profiting in the markets.
New traders often struggle with properly identifying the proper trend on a chart. There are some technical tools that can assist them with trend identification. One such tool is the moving average. Moving averages simply average the previous closing prices of a security. If the current price is above the previous closing averages, then you are likely in an uptrend. When the current price is trading below the previous closes, then you are likely in a downtrend.
Another issue for traders is which moving average is the correct one to use. Last month, I discussed the usefulness of identifying the cycle of a security as an odds enhancer for predicting potential highs and lows in price. Knowing the stock cycle may also help you in figuring out which moving average length will be best to use.
All securities have cycles that affect the price movement. As indicated in the prior article, if we can identify the cycle that is dominating our stock, we can identify with a higher probability when tops and bottoms in price will occur and when we should buy or sell our stock. Stock cycles are measured from trough to trough. The troughs are the low points in price that correspond with the lows in the cycle.
Looking at the 30 minute chart of Intel (INTC), we can see that the stock seems to make bottoms at a fairly regular interval.
When we are using moving averages, we acknowledge that it is an average of price and that price will move away from that average and revert back during a trend. The average should be much like the black line dissecting the stock cycle I drew in figure 1. We want an average that is half the length of the cycle so that it will show our peaks and troughs as movements from and to the average itself.
Dividing the 15 period cycle of the INTC chart tells us that we should use an eight period moving average, (15 / 2 = 7.5 so we round up).
In an uptrend, we should see prices move away from the average only to snap back to them when the trough of the cycle occurs. If we are changing to a downtrend, then the average would be violated and the price would bounce off of it to the downside before returning during peaks in the cycle. If the average is being violated in both directions, then we do not have a strong trend in that time frame.
By using the right average for the time frame you are trading, you can increase your odds for success. Just be careful to check the stock cycle from time to time as cycles can change with market conditions. We need to adapt with the markets for maximum success.
Trend identification is only one part of the Core Strategy. In addition to knowing which direction to trade, you need to know the correct entry and exit points. These points are known as Supply and Demand Zones. To learn how to discover these zones, visit your local Online Trading Academy center today! Until next time, trade safe and trade well!