Friday, January 21

The essence of technical analysis


Among all the arsenal traders have to certify in which direction the trend has changed, mean crossovers are one of the most widely used tools in trading.

They represent the essence of technical analysis properly speaking, since unlike “chartism”, these crosses are obtained from the application of mathematical and statistical formulas to prices and the volume traded.

The most used indicator is the moving average, which is built with price data from a given period. For example, the last fifty sessions.

By their very nature, they are lagged indices, and unlike a double bottom or a head and shoulders pattern, which anticipate the change in trend, the moving average reacts when this change has already occurred, and confirms it. Therefore, it is a follower indicator and not a leader.

The calculation period, essential for a good trading

One factor to consider with moving averages is the calculation period. The higher it is, the more data is needed and the longer the delay.

On the contrary, the shorter the term, the better it will follow the price, although its movements will be much more abrupt, less smoothed, and it will provide more false signals. Normally, averages with calculation periods between 3 and 21 days are considered short-term, up to 150 days in the medium term, and from here on, we speak of long-term.

To determine the long-term trend of an asset, the most followed average is 200 sessions. It can be calculated with any time frame. For example, on 5-minute charts for intraday operations, or with daily data for other types of trading.

Signals through price

The simplest way to trade an average is to look for signals through price. That is, when the price closes above the average there is a buy signal, and if it closes below there is a sell signal.

Investors who trade very short term will have to use short averages, but in this case, there is a risk that there will be too many false signals. This risk multiplies in side markets.

“Using the averages in a pure way with the simple cut of the price is not usually the most common because it generates many false signals, especially if you work with short periods. This is so because it is not possible to filter the noise “, he explains Josep Codina, INVERSION analyst.

In longer periods, “the delay that the average can take will reduce the effectiveness of the anticipation, but will generate greater reliability,” he emphasizes. Codina. In this sense, the absolute star is the average of 200 sessions, used to track long-term trends. “It works like clockwork,” he adds. Roberto Moro, a technical analyst for the firm robertomoro.com.

The filter problem

To avoid the problem of false signals, many traders hope that the price crosses the average by a certain percentage to validate the signal. The key is to choose the percentage well.

Another technique is to use time filters, that is, wait two or three days to validate the signal. The crosses of averages with the price that should be monitored are those of 10, 20, 50, 100 and 200 sessions, depending on the terms in which it operates.

The problem posed by these filters, as explained Codina, is that “they are complicated to fix and vary greatly depending on the type of asset” on which it operates.

When a percentage is applied on the average as a filter, in reality a band is generated whose limits activate the entry or exit in the market. “When we use these bands, what we do is come and go later, so the benefit of good operations is reduced,” he adds. Codina.

In his opinion, it is necessary to assess whether this compensates in exchange for eliminating false signals. This idea of ​​delay is also shared by Moro when he says that the averages in general are indicators “too late”, except for the exception of the average of 200 sessions.

False signals in the Banco Santander price

The crosses of stockings

All of these problems can best be dealt with with the use of the middle crosses. The most widely used method is the crossing of two means of different periods, one short and the other long. In short-term operations, the measures of 8 and 21 sessions are usually used.

When the first (short) crosses up the second (long), a buy signal is produced. And vice versa. These periods are merely indicative, since each trader will use the averages that best suit his style, as long as there is sufficient separation between the two.

For investors looking for medium and long-term entries, the most common is to use an average of 50 sessions and another of 200 sessions. When the first cuts up the second, what is known as “golden cross”And one of the buying signals most sought after by investors is generated.

Smoother movements

“Orthodoxy says that it is a sign that the market enters a medium-term upward trend in a sustained way, since they are averages with periods that work the bottom of the market and upwards mark this situation”, he recalls Codina.

The opposite case, when the average of 50 sessions cuts down to the average of 200 sessions, is what is known as ‘death crossing’ and it has significant bearish implications.

By representing trend movements in the medium and long term, these crosses are usually used as a reference even for investors who are not lovers of technical analysis, since they present little noise and generate very smooth movements.

However, Codina explains that “just in the cut-off periods, the probabilities that a false crossover may occur or that the price will turn after a few sessions exist.” Therefore, it is necessary to analyze in detail the slopes with which the cuts occur.

Trading: The Essence of Technical Analysis |  Author of the article: José Jiménez
Golden crossover and death crossover on the S & P500

The usefulness of moving averages

The sources consulted by INVERSIÓN acknowledge that moving averages are one of the most popular indicators in trading. But like all tools, they do not assume the absolute truth.

“They are a useful tool that should be part of our arsenal, either as a plan or as a system to generate signals, but like all other indicators we cannot pretend that they are infallible,” he warns. Codina.

They work well when the price is trending but lose effectiveness in lateral periods. Many investors use them as dynamic support or resistance, so their breakout to the upside or downside can trigger strong price swings.

When operating, Codina suggests opening the range and using at least two averages and analyzing their crosses, to better detect possible false signals, especially in short time frames. Another utility of averages is to apply them to other indicators to reduce their noise and facilitate operations.



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