From the November 01, 2008 issue of Futures Magazine • Subscribe!

Using moving averages to do better than average

BREAKING THROUGH

“How sweet it isn’t” (above) shows another example of how an average keyed in off an important Fibonacci level. The first test comes after a big move at the 15 level where the 50-day moving average is close to the 38% retracement of this entire leg. After an extended move, it may take multiple tests before the failure materializes. In this case, price action tests the line for seven trading sessions before closing below it.

Once the 50-day is broken, odds increase that either the 61% retracement or 200-day moving average will be tested. On daily charts, these two markers are close and create more of a support zone as opposed to a line in the sand.

The initial test of the 200-day leaves a tail below the 61% level at 13.70 only to come close to the 200-day before closing back above the retracement line. From there, the 200-day is tested again and it holds. What that means for the time being is this particular market is tracing out an intermediate-level correction as it successfully defends the 200-day. It is only when the next failure at the 50-day kicks in does the 200-day ultimately fail on the last turn down.

Once price action holds at the 200-day and the next test of the 50-day happens by default, former support (the initial test of the 50-day at 15) acts as resistance. If the 50-day is taken out at this point, chances increase for a new bull leg. It is this combination of the moving average and potential flip in polarity that makes this a good shorting opportunity. This is one of those areas on the chart that acts as a magnet to the price action. Finally, once the 200-day breaks, prices go appreciably lower (not shown on this chart).

ATTRACTING ATTENTION

Another important characteristic of moving averages is they serve as points where benign pullbacks compete for buyers to establish initial positions or add to profitable positions.

Keep in mind, the better these charts are organized and respect the moving averages, the greater the underlying strength of a particular market. “Sox rocks” depicts price action in the Philadelphia Exchanges Semiconductor index (SOX) from the 2003-04 rally after the bear market bottom was retested.

The 50-day is tested numerous times but never breaks for more than a day or two, making each test an opportunity to buy the dip. The best buying opportunities materialize when the test of the line clusters with a universal time window. The cluster with the time window is not a requirement but it certainly helps when you’re looking for a reason to have conviction to stay with a move. On this chart, two of the better opportunities materialized when price action was 127 and 161 days respectively off the low. While it is not shown on this chart, this leg did complete when it hit the 233-day window off the 2003 low.

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