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posted on 19 November 2015

Moving Average Strategy Not Working For You?

by Sam Seiden, Online Trading Academy

Online Trading Academy Article of the Week

The Moving Average... It is a tool that is talked about in almost every trading book that has ever been written. Every day, those on TV, CNBC, Bloomberg and others are telling us where the S&P and other key markets are in relation to the 200 day moving average, for example.

Every charting package on the planet comes with every possible configuration of a moving average for you to use. Because of all this, moving averages must be one of the most important tools for traders and investors, right? You start to think that it must be impossible to make money in the markets without using moving averages. When we take a deeper look into the purpose and result of using moving averages, you start to see that not only do you not need to use them but, more importantly, they can actually hurt you if you don't understand the risk that comes from using them as a primary buy and sell decision making tool and that is the focus of this piece.

Instead of going through many old charts to find the perfect picture to use as an example to illustrate my logic, I like to use real trading examples from our live trading rooms or one of our other services. We identified many levels on our Supply and Demand grid from November 3rd below, but for this piece let's focus on one supply level from the grid. This was a supply level in Soybean Futures (black box). Once price rallied the plan was to sell it when it reached our supply level with a protective buy stop just above the level to manage the risk and have our profit targets below.

OTA Supply/Demand Grid - Nov. 3, 2015: The Setup

How to find supply and demand levels in the market

Price rallied to the supply level where our students are instructed to sell shortly after the market got going. Price moved lower after reaching the level and the trade worked out very well for our grid members who took the trading opportunity. They followed the rules and executed our rule based market timing strategy.

Now, let's go over the same trading opportunity but instead of applying our strategy, let's use a moving average which again, is a tool talked about in almost every trading book ever written. Most people are taught to sell when the moving average turns lower. As you can see here, by the time the moving average turns lower price has already declined quite a bit, which means high risk and lower reward if you use your moving average as a sell signal.

Furthermore, notice that the moving average was sloping up when our rules gave the sell signal at supply. Have you ever read a trading book that said sell when the moving average is sloping up? Also, notice that the short term trend of price was up when our strategy gave us the low risk sell signal at supply. Again, have you ever read a trading book that said to sell in an uptrend? Of course not.

Yet buying low and selling high is the proper action you take when you buy and sell anything in life, isn't it? This is exactly how you make money trading as well, but the trading and investing books almost always teach you to do the opposite which is very flawed. Many of the traders following indicators such as moving averages are really smart people who have the best of intentions, they've just been taught wrong. It's not rocket science, traditional technical analysis can be overly complex, often inaccurate and may cause "paralysis by analysis." This is why I have focused on teaching people our simple rule based strategy using the principals of supply and demand aimed to help them find real low risk, high reward and high probability opportunities.

Waiting for the moving average to turn before you enter a position in the market certainly gives confirmation, but the cost of that confirmation is extremely high risk and lower reward trading opportunities. Furthermore, that confirmation is an illusion because you still don't know exactly what price will do next, trading is all about probability and entering a position when the odds are stacked in your favor.

Soybeans - Nov. 3, 2015: The Result

How to use moving average correctly

Again, there are so many books on trading and investing and most people start the learning process by reading the books, yet the vast majority of traders and investors fail when it comes to achieving their financial goals. For the most part, books and the internet are loaded with the same conventional technical and fundamental analysis concepts.

Specifically, most of the conventional technical analysis includes indicators and oscillators such as Stochastics, Mac-D, moving averages and so on. Here is the problem... conventional technical analysis is a lagging school of thought that leads to high risk, low reward and low probability trading and investing.

All indicators are simply a derivative of price, meaning they lag price. By the time they tell you to buy or sell, the low risk, high reward opportunity has passed. They have you buying after a rally in price and selling after price has already declined. At Online Trading Academy, we don't use conventional indicators, oscillators or chart patterns that you read about in the trading books as primary decision making tools because adding any decision making tool to our analysis process that lags price only increases risk and decreases reward and teaching this would be very irresponsible. Why would I ever want to do that?

I know the information in trading books has been around for many decades but that doesn't mean it works or helps people. Like learning anything else in life, there is the book version way of learning something and real world learning. At Online Trading Academy, I focus on real world trading and investing which is what our core strategy is made of.

Again, if you think about it, most people read trading books and most people lose money. Maybe they should stop and consider how flawed the logic is in that conventional thought and action. My goal in this piece is to simply open your mind to a lower risk, higher reward way of trading and investing.

Hope this was helpful, have a great day.

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