Moving Averages
average will be to price action. In Figure 11.20, we see moving averages with dif-
ferent periodicities reacting at different rates to rising prices.
The most appropriate lookback period for a moving average depends on the
objective at hand. Simple moving averages with popular periodicities tend to per-
form better as support and resistance, some of which include:■ (^) 20 period
■ (^) 50 period
■ (^) 100 period
■ (^) 200 period
Some practitioners also use Fibonacci-based periodicities on moving averages,
some of which are:
■ (^) 5 period
■ (^) 8 period
■ (^) 13 period
■ (^) 21 period
■ (^) 34 period
■ (^) 55 period
■ (^) 89 period
■ (^) 144 period
Other approaches include tuning it to the quarter, half, or full period of the
dominant cycle in the market or tuning it via visual inspection. Some practitio-
ners also perform back testing to determine the most profitable lookback period
for a certain moving average, over a specified period of observation. Sometimes
practitioners do not require moving averages to act as a barrier to price, but rather
as a timing indicator, relying on the crossover of two moving averages to signal a
buy or sell, or simply to signal potential bullishness or bearishness. In such cases,
the periodicities are chosen to according to the frequency of signals and triggers
required for a particular methodology.
11.2 Nine Main Applications of Moving Averages
(1) as a price Cycle filter
Moving averages are usually used to smooth data so that the trend component is
isolated and emphasized. This is particularly useful during erratic or chaotic price
activity where the trend determination is difficult. It therefore acts as a low-pass
filter of market noise, filtering out all higher-frequency price cycles. The shorter
the periodicity of a cycle, the higher will be its cycle frequency. As such, moving
averages are therefore sometimes used as a proxy for price action in situations
where the general direction of the trend is of greater importance than the actual
price reactions or price rejection levels. See Figure 11.21 for an example of the
200-day moving average filtering out all the smaller price oscillations and fluctua-
tions to indicate the general direction of the longer-term trend.