How to Profit with Simple Moving Averages

12/25/2009 12:01 am EST

Focus: STRATEGIES

Moving averages are one of the most enduring of all technical analysis tools, and for good reason: They can help you to more accurately determine the trend bias of any given market, and without the need for further calculation. If price is above a moving average and the slope of that average is up, then for all intents and purposes, the trend bias is up.

Of course, you may still need to utilize a more specific entry/exit trigger to get you into and out of your trades, but it's always a good idea to begin your analysis by glancing at your key moving averages before anything else. And just what is the best moving average to use, anyway? Here are a few tips regarding a particular moving average that you don't hear too much about.

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FIGURE 1: USD/CAD, DAILY. The first step toward profitable trading is finding a way to determine the primary trend of the market you desire to enter. The 89-period simple moving average does a good job of defining medium- to long-term market trends.

Figure 1 depicts the daily USD/CAD forex cross. The only indicator applied is the 89-period simple moving average (SMA). Yes, it's calculated with a Fibonacci-based number of equally-weighted time periods, and no, I don't believe that an 86- or 92-period SMA would show substantially different results, but since I try to use Fibonacci-based numbers in the various array of technical indicators that I rely on to trade, it only makes sense to keep a certain amount of consistency by applying only Fibonacci-based numbers in all of them.

Regardless, this is a very interesting moving average, one that works pretty well for traders who want to trade only in the direction of the primary trend of a market. The USD/CAD cross has remained below the 89-period SMA since mid-April 2009, even though there have been several significant pullbacks towards it. Using the 89-period SMA would have been helpful to breakout traders desiring to cash in on the various short entries that a 20- or even 55-day channel breakout system would have produced, knowing that they were on the right side of the primary trend in this currency pair. Even the "sell bear market rallies" crowd would likely have found this moving average to have been of substantial benefit, again, because of the added confidence of being properly aligned with the dominant trend.

At times, the 89-period SMA acts as de facto support and resistance, though not quite as much as the more widely used 50-period exponential moving average (EMA) and its 50-period SMA counterpart. You can see several powerful examples of this on the chart, enough to conclude that the number 89 may be in tune with the major cyclical ebb and flow action witnessed in virtually all tradable markets. Plot the 89-period SMA on your own charts and see if it doesn't do an outstanding job of defining primary trends and support/resistance (S/R) areas. Try using it in conjunction with Fibonacci retracement and extension ratios for even more fun with "magic" numbers. You might be surprised at how often things harmonize around key sets of Fibonacci ratios.

There does appear to be a kind of hidden numerical structure to the financial markets, and while none of us will ever be wise enough to figure it all out, we can all be very thankful for the amazing insights provided to us by Leonardo Pisano Bogollo (aka "Fibonacci") in his timeless volume Liber Abaci (1202), the mathematician responsible for the introduction of Arabic numerals and the Fibonacci numerical series that bears his name to Europe. We, as modern daytraders and market analysts, owe him a huge debt of gratitude. I suspect that he would be more than pleased to learn how much we all rely on his work, nearly 810 years after the publication of Liber Abaci.

By Donald Pendergast of ChartW59.com

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