Moving Average Crossovers
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 Qualcomm, Inc. (NASDAQ: QCOM)
This has been a high flying stock and an example of how staying with a
trend can reward the disciplined trader handsomely.
Using our traditional moving average crossover method discussed in this
column often, the goal is to be on the correct side of major trends. This
method does create many whipsaws and a number of small losers when a stock
is in a sideways range.
However, once the trend starts, this method keeps a trader from exiting
early and gives discipline to get back in when indicated. It is a method
that is always has a trader in the market long or short.
After rising from the previous buy signal, on November 2 in the early
afternoon, QCOM signal a Sell signal. An hour later, QCOM reversed and
issued a Buy signal. A disciplined trader getting back in at the close
would have been rewarded for his following a plan. QCOM rose from 224 to an
exit at 360 at noon on November 16. That is a 136 point rise! Now not all
trades work out this well, but many do.
A new Buy signal on November 18 at 3:00 once again reversed a minor now
move has a disciplined trader back in long.
This example shows the profit potential of a trend.
I would be an owner of QCOM here a wait for a new exit signal.
I would have a stop at 345.
