Moving
Average Rainbows – Part 1
Moving averages provide highly intuitive
feedback as they interact directly with price. Indicators placed in a separate lower graph
force the eye to sift through large quantities of noise to identify usable information.
While that analysis will produce powerful results, the filtering process also throws out
important data. Plotted in the price pane, moving averages emit continuous
"signal" without noise.
Apply the convergence-divergence technical tool to this
visual analysis. Since price always moves toward or away from an underlying average, each
new bar or candle uncovers characteristics of momentum, trend and time. And the skilled
trader can access even more powerful information. Add multiple moving
averages into the chart and a complete multi-time frame trend system appears.
Tie multiple moving averages together through any general
mathematical relationship. One classic combination utilizes 18, 50 and 150 periods. Note
that each MA approximates three times the preceding one. This particular set also builds
an effective framework to investigate and trade three distinct periods of trend: short,
intermediate and long-term.
Moving average sets create layers of
convergence-divergence feedback. Instead of price alone moving toward or away from any
average, the averages now move toward and away from each other. Whole trading systems can
be designed that capitalize upon these relationships. The author’s Dip Trip,
Elder’s Triple Screen and Raschke’s 3-10 Divergence
all capture elements of these complex interactions.
But don’t stop at just two or three averages.
Trending stocks emit fractals of price movement unique for each issue. Measure one of
these fingerprints by the depth a stock corrects after each impulse of a trend. Instead
than using complex math to locate these important pivots, traders can construct a Moving
Average Rainbow. MARs consist of major averages, from the shortest to the longest,
all interacting on the same price chart.
Rainbows reveal important and subtle relationships between
price, time and trend. One of the most exciting discoveries uncovers how certain moving
averages develop support and resistance behavior with other ones. This trait alone
provides the trader with a powerful advantage over the competition.
