Looking at Different Ways to Use a Moving Average in Your Trading – Part 2
In my last article I wrote about the different ways to use a moving average, click here to read more about it. This is part 2 of that series, focusing on another non-traditional use for the MA.
Use Number 3 – Using Moving Averages as Support and Resistance Levels
A popular use of Moving Averages is to use them as support and resistance levels. On the chart below we can again see the 50, 100 and 200 Simple Moving Averages (SMA).
I marked areas when price bounced of the SMA's and later produced a good move in the opposite direction. In other words, if price hit the moving average from above, it has to rally higher significantly after bouncing off the MA in order to get marked. Reverse applies for a situation when price hits the MA from below.
The 4h chart above shows a 3 months period between January 1 and March 31 2012. In that timeframe, we can see 9 significant bounces of the moving averages. Of course one could argue that some of the times when price didn't bounce and move far enough to qualify as a good bounce would've been good trades too. It may have been possible to lock in some profits or get out without suffering a full loss on the trade but that really comes down to experience, your specific method of trading and your stop loss and take profit parameters. What works for you may not work for someone else.
When Moving Averages Fail as Support and Resistance Levels
Seeing the 9 bounces above may lead you to think that trading bounces of MA's is easy money, but think again. On the chart below there have been lot of times when price didn't respect the moving average and just shoot past it like it wasn't even there. Other times price eventually respected the MA but probably stopped you out with a big breach of the Average before moving in your desired direction.
In the chart above we can see 9 instances when the SMA's fail to act as support and resistance. Far from being an easy way to print money, trading bounces of moving averages requires decent amount of screen time to identify the “good' from the “bad” bounces. It also probably requires a set of stop loss and take profit parameters specifically tailored for trading around these areas.