The Power of a Simple Moving Average
By Vincent Troncone of www.pennies-from-heaven.us*
Posted: Jul 28, 2006
It seems as though traders have been using the simple moving average (SMA) for years. Until recently, I never even considered the idea because no one ever showed me the value of this particular indicator and how to set it up properly.
I stumbled on this on my own and hope you will benefit from it.
Please look at Chart Figure 1.
The first thing I want you to notice is that, even in a choppy, sideways channel, this setting of 5 on the SMA works incredibly well.
The second thing I want you to look at are the red lines on the chart.
Each vertical red line points to a price bar that has a close above the simple moving average.
With this simple setting, you can see how the SMA catches reversals rather quickly and even gives you the possibility of trading smaller trends in sideways, choppy markets, which is a great benefit to you.
Notice on Chart Figure 1 that, as long as the price bar closes remain above the simple moving average, the trend typically continues up.
On Chart Figure 2, using a 3-minute chart, we have just the opposite. In this example, each vertical red line points to a price bar that has a close below the simple moving average.
As long as the price bar closes remain below the simple moving average, the trend typically continues down.
In either case, when you have a price bar that breaks above the simple moving average and that also has a close above the SMA, that signals a potential long position or entry in the market.
When you have a price bar that breaks below the simple moving average and that also has a close below the SMA, that signals a potential short position or exit in the market.
The rules here are relative to the dominant trend in the time frame you are using. Once again, I am not giving you a 100 percent guarantee that this will work perfectly every single time, but, as you can see, it works quite well.
Now let's see what this looks like on a 15-minute chart (Chart Figure 3).
On Chart Figure 3, the blue vertical lines represent price bar closes above the SMA and the red vertical lines represent the price bar closes below the SMA.
Finally, we will look at this same concept on a daily sugar chart (Chart Figure 4).
In this example on a daily chart, you can see that we have numerous examples of price bars that closed above the SMA as pointed out by the blue vertical lines, even much more then I have represented here.
I would like to bring to your attention the symmetry of the price action around the 5-period simple moving average.
The 5-period SMA almost acts as a center line or balance point, and, when the line is broken to either side, it is a possible entry or exit point in the market.
Also pay attention to how the 5-period SMA even works when the price is in a sideways, choppy market in April and May.
I discovered that this setting of a 5-period SMA works well in all the time frames I have used, from a tick chart up to a monthly chart.
*Reprinted (and modified) with permission from Vincent Troncone. (Email: Info@pennies-from-heaven.us, website: www.pennies-from-heaven.us) . Futures and options trading involve high risk, and you can lose a lot of money. When investing in futures, you may lose more than your original investment. When purchasing options, you may lose all of the money you invested. According to many experts, most individual investors who trade commodity futures or options lose money. There is a substantial risk of loss in trading futures and options. Do not risk money you cannot afford to lose. Past results are not necessarily indicative of future results. There is no guarantee that the information in this article will generate profits for the reader. All charts are provided by FutureSource.com, a division of eSignal.
Read More Weekly Trading Education Articles.
