The Many Applications of the Moving Average – Part 3 (of 7)

By Fan Yang - FXTimes
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3) Other multiple moving average systems:

Analytical and trading signals can be created with more moving averages as well.

- 3 moving average system: With an additional MA we can generate entry signals different from exit signals. This attempts to deal with the usual lag that 2 MA crossover systems have. The idea is to enter when medium length MA crosses longer term MA. Exit is provided when short-term MA crosses the medium one.

Entry and Re-entry Into a Trend:

Here is an example I dug up representing a 3-MA crossover system using 4, 9, and 18 SMAs and the entry and exit signals it provided during a time EUR/USD trended down.

The Many Applications of the Moving Average – Part 3 (of 7)
The Many Applications of the Moving Average – Part 3 (of 7)

Shake-out Exits

The quicker exit helps a bit in certain situations. But at other times, it will exit too early if the trend develops after a deep retracement. This example shows an exit signal that would have taken us out of the market before most of the downtrend developed. Then as the market bottomed, we got a long entry signal, but also got a quick exit signal before it eventually extended the rally.

early exit in 3-MA crossover

- 4 moving average system: Another additional MA is added for the purpose to filtering out signals so as to only provide those in the direction of the trend.

4-moving average crossover

This 4-moving averages system is basically our previously noted 2-moving average system using an additional set of 2 moving averages to filter out a general direction.

As you can imagine, you can also use 5MA system, where we can use the 3MA crossover system for basic entry and exit signals, with an addition 2-moving average sets to filter out the general trend to trade into .

The combination of things you can do with crossovers and filters grow as you add MAs, but I think we can stop at 5 for now as not to over-complicate it.

Moving average congestion-breakout signals: Another use of MA is to use multiple MAs to look for congestion. Since MAs represent price action of different degree, convergence of MAs suggest a loss of direction. This is usually accompanied by sideways price action. Then when the market decides on a direction, and price action starts to “pop” out from the moving averages, we have a breakout signal. Note that the breakout is only an entry signal.

In this example we have the simple moving averages with periods 200, 100, 55, 21, and 8. For a period of time here toward the end of May 2012, these moving averages in the 1H chart converged together. Price action also whipped back and forth these moving averages while they also crossover each other up and down a few times.

Toward the right side of the chart, price action fell, and the moving averages aligned in such a way that the largest period started on top down to the lowest period at the bottom. The fact the moving averages spread apart after a period of congestion reflects a trend breaking out of a consolidation period.


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