"Triple Moving Averages" Explained

Those who have followed my work for some time know that I take a "toolbox" approach to analyzing and trading markets. The more technical and analytical tools I have in my trading toolbox at my disposal, the better my chances for success in trading. One of my favorite "secondary" trading tools is moving averages.

In a past educational feature, I explained how I use my two favorite moving averages: the 9- and 18-period moving averages. In this feature, I will discuss using three moving averages in analyzing and trading a market. It's called the "triple-moving average" method.

The moving average is one of the most commonly used technical tools. In a simple moving average, the mathematical median of the underlying price is calculated over an observation period. Prices (usually closing prices) over this period are added and then divided by the total number of time periods. Every day of the observation period is given the same weighting in simple moving averages. Some moving averages give greater weight to more recent prices in the observation period. These are called exponential or weighted moving averages.

The length of time (the number of bars) calculated in a moving average is very important. Moving averages with shorter time periods normally fluctuate and are likely to give more trading signals. Slower moving averages use longer time periods and display a smoother moving average. The slower averages, however, may be too slow to enable you to establish a long or short position effectively. Moving averages follow the trend while smoothing the price movement. The simple moving average is most commonly combined with other simple moving averages to indicate buy and sell signals.

In the triple-moving-average method, "period" lengths typically consist of short, intermediate, and long-term moving averages. A commonly used system in futures trading is 4-, 9-, and 18­period moving averages. Keep in mind a time "period" may be minutes, days, weeks, or even months. Typically, moving averages are used in the shorter time periods, and not on the longer-term weekly and monthly bar charts.

The trading signals generated by a triple moving average may be interpreted as follows: The shorter-term moving average above the longer-term average indicates a bullish market. When the shorter-term moving average crosses below the longer-term moving average, the market is viewed as bearish and a sell signal is generated. If the shorter-term moving average remains below the longer-term moving average, the market is still considered bearish. When the shorter-term average crosses above the longer-term average, a possible reversal to a bearish market is signaled.

The relation of the three moving averages can help to better and more quickly define the strength of the trend and provide shorter-term trading clues. For example, if the 4-period moving average crosses above the 9-period average, but the 9-period is still below the 18-period, that signals a trend change may be on the horizon, but it's best to wait for the 9-period to cross above the 18­period for a better reading of the trend change.

The trader who uses shorter timeframes to trade markets is better suited to using the triple-moving-average method--because trading signals are given faster. But keep in mind the shorter the moving average, the greater the potential for false signals.

Here is an important caveat about using moving averages when trading futures markets: They do not work well in choppy or non-trending markets. One can develop a severe case of whiplash using moving averages in choppy, sideways markets. Conversely, in trending markets, moving averages can work very well.

When looking at a daily bar chart, one can plot different moving averages (provided you have the proper charting software) and immediately see if they have worked well at providing buy and sell signals during the past few months of price history on the chart.

As an aside, veteran ag market watchers say the "commodity funds" (the big trading funds that many times seem to dominate futures market trading) follow the 40-day moving average very closely when they trade the grains. Thus, if you see a grain market that is getting ready to cross above or below the 40-day moving average, it just may be that the funds could become more active.

Jim Wyckoff
TradingEducation.com