A Common Myth About Moving Averages

05/29/2012 11:38 am EST

Focus: STRATEGIES

Many traders incorrectly believe moving averages are lagging indicators with little or no trading merit, but Coach Shane of NetPicks.com proves that when applied properly, they present timely and accurate signals.

Like many of you, I started trading by picking up pieces here and there through books, on the Internet and in the many forums that populate cyberspace. The absolute worst were the forums! I admit there were a few good things, but overall, it was fluff and those who wrote it usually were changing their systems/strategy/method after someone would post their own trading information. 

Books, in general, were simply a rehash of the basics with a little twist tossed in. Actually, some had no twist, but just the basics explained a little differently.

If you are going to enter a profession, don’t you owe it to yourself to at least arm yourself with proper knowledge? Look at it this way (this is how I did, anyhow): You are entering a profession where you can make a lot of money. You are entering a profession where some traders trade, as a routine, ten, 20, or 50 million dollars at a time! You are entering a profession where the weak and uneducated are culled from the herd on a daily basis.

I can remember when the shoe dropped for me and I decided that I needed to think and act like a pro. Before I share it, let me just say that it was not something that turned me into a mega-profitable trader. 

You have seen those ads, right? The ones where some ex-banker has “unlocked the secrets to the FX ATM where you can withdrawal at will!” This realization is what started me down a different path. It was a revelation that most have no clue what they are talking about and seeking out experience was crucial to any advancement.

Here is a trading question for you: are moving averages lagging indicators?

The common answer you probably see on the forums is yes; they are lagging and are useless because price has already moved by the time the moving average catches up.

If you gave that answer, you should be front of the line for trading education from reputable sources because you have bought into a myth.

See also: The Prominent Indicator You Can’t Trust

I am going to answer the question with a chart showing a currency pair in a downtrend.

chart
Click to Enlarge

This is a moving average crossover system, and as you can clearly see, yes, moving averages lagged price when you used them in this fashion. As a matter of fact, it got you in the market at horrible times! 

So yes, they are lagging in this example, but useless? Well, it makes sense and perhaps that trader is correct in saying so.

Or does it? Take a look at the same chart below with the same moving averages.

chart
Click to Enlarge

This is the same chart with the same moving averages. Instead of using a crossover system, I am using the moving averages as dynamic support and resistance. You can see how price respected both of the averages. 

Depending on how you play these, there are at least four opportunities to short this market! Do you see any lag at all? Could you have traded this? You bet you could have.

So in this case, that trader who said with a definite tone that moving averages were lagging and useless did you a great disservice.

This was a revelation to me at the time. It opened doors to using this knowledge and being able to have a better grasp at where prices could run into problems in their advancement. 

It also had the potential to be a trading strategy in itself, and all of this was possible because I had the desire to take a more professional approach to my trading. It did not matter if I was trading a strict system or discretion, I could utilize this to increase the potential of my trades.

One piece of advice I would offer to you is, yes, you can learn all of this on your own through trial and error, but shorten the learning curve. If you are able to locate someone who makes this their living and is willing to cover “what they know,” take them up on their offer.

See related: The Best Market for Beginning Traders

By Coach Shane, contributor, NetPicks.com

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