Good strategies based on moving averages for the stock market

Marketplace: stock;
Indicators: EMA, MA, ADX;
Strategy: trending.

In this article we will look at specific trading methods that are built on the features of moving averages.

Trading Strategy #1 "Cup with a Handle"

A cup with a handle is a typical reversal modelwhich often precedes big rallies. It is formed when a stock falls, draws a bottom, and then begins to rise, forming a "cup". After the rise, the stock drifts downward, forming a "handle" pattern. According to William O'Neill, who popularized this model, the best candidates for a cup and handle model are. stockswhich have already shown strong rallies.

One way to measure "strong rallies" is to use the 50-day moving average. As long as a stock remains above the 50-day average, it can be considered to be in an intermediate-term uptrend. Therefore, a cup with a handle that has formed at or above the 50-day moving average strengthens the signal.

Fig. 1. Cup with Handle. Note the shape of the cup at and above the 50-day average.

Trading strategy #2 "Pivot points"

As a rule, the 50-day simple average provides a reference point for many financial institutions and large traders. Jeff Cooper noted that "a stock will trade around its 50-day average for a while and then explode up or down without warning. This implosion often takes at least a few days...." His strategy looks for a day of extended trading range that occurs in a stock trading around its 50-day average, and then opens a position in the direction of that extension.

Figure 2: Pivot Points. Entries after wide range movements on the 50-day average.

Trading strategy "Holy Grail"

In their book Street Smarts, Connors and Raschke showed that trend markets often roll back to the middle before continuing the move. If you think about it, it makes sense. Essentially, you need to find a trending market with a high ADX accompanied by a pullback to a representative 20-period average. They have jokingly called this model the "Holy Grail.

Fig. 3. Holy Grail. The model is built on the resumption of a strong trend with high ADX after a pullback to the moving average.

Trading strategy "Gaps"

Often markets will trade around the average. They will show small ups (or downs) and then return to the average. This is known as return to the middle (average number). At the right opportunity, the market will break free and go far away from the average in the trend.

When looking for a long-term system that follows a trend, I noticed that this trends or breakthroughs from the averages are often preceded by a period of at least two days when a decline (for uptrends) or an increase (for downtrends trends) will not be able to touch the average. Such a "gap" above and below the average is called a "gap" because you see a "light" gap between the price and the average.

The original trading system, the 2/20-Day EMA Breakout System, used a 20-day exponential average. Once the entry conditions are met, a buy order is placed over the high of the last two bars. Short trades are fully mirrored.

Figure 4. 2/20 EMA Breakout trading system

Fig. 5. February Comex Gold

Note how 2/20 EMA Breakthroughs (or "gaps" require the market to trade above the two-day high for longs and below the two-day low for shorts. If the market fails to overcome these points, there will be no trade.

As well as others. trading systemsIn the case of the trend, Prospects are prone to losses when traded mechanically, as markets are only in trend for about 30% of the time. However, when used deliberately, in combination with money management and/or additional technical indicators (that is, when the underlying trend is strong), they can be a useful tool. In addition, you might consider different magnitudes (and types) of averages used, depending on your trading style. For example, short-term traders might use 10-period averages, while long-term investors might use 50-period or longer averages.

Conclusion

So which is the best way? It depends on personal preference and trading style. Study the different types of averages. Tweak them to your liking or create your own methods.