Moving Averages, Time Frames and Complexity in Trading

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One of the first algorithmic trading programs I learnt was just a moving average crossover strategy. When I saw how it was failing all the times I asked myself: why is the person who wrote this book making me wasting my time with this since it does not work? Should I return this book?

Time after I read just the opposite, a book related to mutual funds trading strategies. This time you had to buy when the fast trend crossed the slow one downwards and sell when that fast moving average crossed the slow one from below. Everything a nonsense that, after backtesting, was a failure. Then I read the contrarians books. I must confess that the contrarians seemed to me unnatural. Because one thing is taking profits from price bounces, that is right, but another thing is going against the trend and thinking you are smarter than the rest of the seven billion souls that live in this world. The trend is your friend, the trend is your friend, be like water and follow the slopping trend my friend.

One should not think that the moving average and the trend are the same stuff. The moving average is a rolling average that takes a particular fixed number of past periods and averages. The trend can be defined in different ways but it is more related to how price evolves in time, more related to price action. Different authors use different definitions for trends to build their strategies accordingly.

I have my own interpretation of what means the moving average and how it should be used for trading. I use short moving averages, between 20-30 periods and have a few techniques that require confirmation through EMA. When I say confirmation is just that the EMA do not constitute the trade signal, but the confirmation of the signal. A signal given by the current price action. I do not use indicators by the way.

Then, for me, the moving average is the level in which price finds equillibrium after price momentum is temporarily stopped. Generally speaking, once price reaches the EMA level, under certain price action, the EMA will react and push the price away from it creating a new anchor point. I really appreciate Bob Volman’s price action methodology, he calls it a magnet effect.

Most trading strategies rely on a certain number of pips or levels. I have found easier to trade with a particular number of bars instead. That is maybe why I have a particular preference for binary options, because they focus in time instead of volatility, if I trade bars I want to think in terms of bars, not in terms of price. Indeed, traditional charts are based in time but most people try to trade with these in terms of volatility which is not strictly precise in my opinion. This is another issue however.

What do you think it would be easier? Reading 500 candles and analysing the price action within those or reading just 5 candles for the same purpose?

Trying to answer this question what I did is reducing the number of periods of my EMA at the same time I increased the timeframe I was analysing. Now I have fewer things to take into account to find patterns. At least fewer bars. When you learn Price Action trading, one of the aspects is being able to mentally combine multiple bars into one and also the opposite, mentally being able to dissect one single bar, especially if you are tracking it in real time into smaller multiple bars.

At the end, the number of periods of your moving average define the volatility you want to be exposed to as well as the chosen time frame for a specific instrument.

Another aspect is trade frequency. As a financial manager you want to be able to get your profit asap to be able to reinvest and increase your next absolute profit risking the same relative proportion of your capital, taking advantage of the compounding profit effect. Fast frequency time frames are my favourites for this reason and for other reasons too. In fact one of my current projects is generating data charts according to predefined patterns generation to find the right frequency any asset should be traded at a certain moment in time.

Now it is noticeable that the topic around the moving average and timeframes is defined for can lead to many different and valid approaches. In technical analysis absolute price levels are important. Moving averages are also price levels, but relative this time, that I understand as takeoff or balance areas that follow prices. And when both price and averages meet things occur. I have not found nor really researched reliable mean crossover techniques and all of those I have read in multiple books were losers to such a degree that I do not trust who writes strategies based purely on what the moving averages are doing.

Reducing the complexity of your model increases intelligibility. Therefore I only use one EMA, not multiple moving averages. If I can also define a strategy based on one sole candle instead of waiting for a buch of uncertain bars to be formed I definetively would choose it. Here, again, binary options offer many opportunities; but I do it for Forex as well, since for me there is no technical difference between binary option trading and stock or Forex trading.

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