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 Oracle Corporation (NASDAQ: ORCL).
Over the past 4 weeks, following our basic moving average method would have
produced some very profitable trades in ORCL.
The most recent entry from December 6 would have a trader up over 20 points.
Today, December 27, 1999, ORCL flashed a sell signal at midday.
On any weakness in the morning having the stock move below 102 3/8, I would
exit longs in ORCL.
An aggressive trader would short ORCL at 102 3/8 on weakness.
I would place my stop at 106, as the stock should continue down from this
break of support at 102 3/8.
