Everyone has heard the saying “Let your profits run”. This is one of the
basic approaches to trading. How does a trader “Let profits run” and know
when to enter and exit? The use of moving averages is the choice of many
traders.
Most of the time most stocks are in a trading range. When a trend starts,
it can last a long time producing superior profits.
Moving averages are one of the oldest and most popular technical analysis
tools.
A moving average is the average price of a security at a given time. When
calculating a moving average, you specify the time span to calculate the
average price for X number of periods. For example, 20 periods. These
periods may be 5 minute bars, 15 minute bars, 60 minute or daily bars.
The classic interpretation of a moving average is to use it to observe
changes in prices. Investors typically buy when a security's price rises
above its moving average and sell when the price falls below its moving
average.
The moving average crossover method calculates two moving averages, each
based on a different number of periods of trading data. When the
shorter-term (fewer periods) average crosses above the longer-term average
from below, this is a buy signal for the next bar’s open. When the
shorter-term average crosses below the longer-term average from above, this
is a sell signal for the next bar’s open.
The current charts we are using calculate a 5-period and a 20-period
exponential MA of the closing prices on 60 minute bars. If the 5-period MA
crosses above (becomes greater than) the 20-period MA, you would buy the
next bars opening because the system is saying that an uptrend has begun.
You maintain this long position as long as the 5-period MA is greater than
the 20-period MA. When the 5-period MA crosses below the 20-period MA, the
trend is now down and you would liquidate your long position and establish a
new short position on the next bars open.
Let’s look at Lucent Technology (NYSE:
LU)
Sometimes a good company's stock price goes down.
In late July, LU broke major support on a daily basis.
A short term trader, using hourly bars as we do here in this column, would
have had many good trades using moving average crossovers.
The most recent trade after a small whip saw would have a trader short at
37.
How low can LU go?
Stay with a plan and if you are using moving averages, just wait until the
shorter moving average crosses the longer.
Watch your hourly charts, and stay the course until a Buy signal reverses
the trade.
