Page 210 - THE MARKET WHISPERER

206 PART 7 - Indicators: The Trader’s Compass

The Achilles heel of moving averages is that the data is historical, i.e.,
it relates to information from the past and is therefore known as a trend-
following indicator, or “lagging” indicator. The more we distance over
the axis of time, the data used to calculate the average at the start of the
period becomes much less relevant to the present. For this reason, instead
of being assisted by a simple moving average giving equal weight to each
timeframe, many traders use the exponential moving average, which
gives greater weight to the timeframe closest to the present. In other
words, closing prices of the more recent timeframes are considered more
meaningful than those of the more distant timeframes. There is some logic
to this approach, of course, but we need to keep in mind that the essential
use of the MA is to act as an indicator alone. Interestingly, traders using
the regular MA will reach the same conclusions as those using the EMA.
It’s more a matter of habit, preference, and experience than anything else,
so just go ahead and use whichever MA appeals to you most. New traders
will generally prefer the EMA, but even then they tend to use the SMA
when relating to 200 timeframes. Why? That’s the norm, so that’s what
you should follow too.

“Fast” and “Slow” Averages

A long-range moving average, such as 200MA, is less sensitive to recent
closing price differences, since the weight of each timeframe is relatively
small, and therefore changes will be “slower.” A short-range moving
average, such as 20MA, shows higher sensitivity to recent closing prices,
so changes will be “faster.” As we will see, integrating the slow and fast MA
can be a good indicator of trend direction.

Within the trading session and using five-minute candles, we would
prefer to use the 8MA or the 10MA. For longer-term trade, such as when
reviewing the chart for the purpose of entering a swing of several days,
we would use the 20MA, the 50MA and the 200MA. Later, we will practice
their correct application.

How to Apply the MA

As noted, the MA assists us in defining the trend. Identifying the trend and
its reversals can be done in two ways: examining the link between MA and
the Japanese candle chart, and examining the links between the MAs. In
addition to trend analysis, the MA also serves to define the entry and exit
points, as we will learn later.

When analyzing the meaning of MAs for a stock that is trending up,