This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com
There have been a couple of questions at Wallstreak about PMAs. Mainly, what are they? I first came across this idea in Mark Fisher’s, The Logical Trader. They are calculated using the average of the high, low, and close of each bar. Richard uses the average of the high and low which seems to produce very similar lines. The reason I use PMAs, especially on intra day charts, is to minimize the importance of the bar’s close. On a fast chart such as the 5′, the close is an arbitrary number. That same reasoning is what keeps me from putting too much importance on any individual candle.
As Fisher points out in his book, don’t focus on moving averages as barriers to be crossed, look at the slope of the pivot moving average line. A change in slope is an important indication of a change in perception in the market. He goes over specific strategies and periods that he uses which I won’t get into here. Instead I will focus on how I use them, and why I came up with this approach.
Like many traders, I have a few strategies. Some work great in rangebound markets — variations of divergence plays. Others work great when the market is trending. My only problem was that I had a hard time switching strategies. I would recognize a divergence between momentum and price, for example, and go short only to be stopped out. On days when I recognized the correct phase of the market, I would make money. On the other days, I would take multiple stops. To add insult to injury, after being stopped out of a divergence trade, I would have to watch the market run away without me. Psychologically, it wasn’t a good place.
Now I focus on finding intra day trends. I don’t trade counter-trend strategies at all. However, to make it work financially, I had to find a way to hold onto my winners. There are a few pieces to that puzzle, but PMAs have helped immensely.
I’m posting a chart of yesterday’s crude action, because it illustrates quite well how I use the PMAs. I made three trades yesterday. I scratched the first trade, because I didn’t like the price action, and wasn’t getting the follow through expected. The next two trades are highlighted. Both solid blue thick lines mark important points on the chart for each trade. They were wide range bars that sold off on heavy volume. That was not my signal for entry, but to watch closely for a place to get short.
After each bar, crude formed a bear flag. I went short on a breakdown from each channel. The 1st trade marked resulted in a 40 cent gain, and the 2nd was for 85 cents. I actually trade the QM, because of the lower multiplier, but trade off the CL which is what I’m posting here. The CL is the dog that wags the QM’s tail.
The PMAs were not used for entry on either trade. I made the lines thicker, so they are able to be seen. The white line is the 5, the purple is the 8, and the black line is the 13. As you can see on the chart that each of these lines converged just before bear flags broke to the downside. Once I initiated entry, I was anticipating a quick resumption of the trend. As prices started falling what I wanted to see was the PMAs spreading out. This indicates an acceleration of the trend. I covered the 1st trade when it was retesting the lows of the day. It formed a hammer on heavy volume, so that was a clue to exit. However, it formed another bear flag. After I was short the 2nd time, there was about 30 minutes left in the crude session. As you can see the bands spread out nicely, and even the 5 pma never came close to even turning back up. When I get a nice solid gain, and they PMAs are separating, I have more confidence to hold onto my trade. It helps me not to get shaken out of a great trade. I rely less on any individual candlestick at this point. I’m watching the bollinger bands, hourly support/resistance, standard moving averages on the daily, the clock, and my PMAs to determine if its time to exit. On a strong trend, I have found that using the center band (13 pma) is often a good place to trail my stop. Its just one minor tool that I use to determine the health, or strength of a trade that I’m in.
Excellent explanation T’Worm. I will start using PMA’s in QT…..
cool
Thanks for the tip. They do seem to help get perpective on maintaining a position. Combine them with a Sto %K of 7, and %D of 10. Again going with the slope, enter when %K punches above (Long) or below (Short), and then maintain the position with the PMA’s.
A good example is MGM on 5 minute chart today at 8:25 PDT. One would still be in the position at +.90 but close to an exit. Entry on the Sto cross, and see the SMA spread as the profit increased.
- TraderD
TraderD: interesting idea…i will have to check that out…thanks
“On a fast chart such as the 5′, the close is an arbitrary number.”
John, if the number is arbitrary, then the average of that number would be the average of an arbitrary number. Which is arbitrary. I do not agree with yor statement. I feel the most important number is the close of that candle, considering volume, in your given time frame. Moving averages, however they are calculated, can be uesd to guage momentum.
zoomie: certain candles after rinse jobs or that test specific levels may not be arbritrary, but the close of “every” candle in my opinion is very arbitrary – especially on intraday charts…on daily or weeky charts, i think the close should possibly carry more weight
as far as guaging momentum, i didn’t mean to imply that PMAs are better at guaging them per se…the way they separate or converge will do the same thing no matter how they are calculated…if they are plotted simultaneously, there really isn’t much difference…as with everything else in TA, its a matter of preference and comfort
as far as the average being arbritray also, i totally disagree with that…the slope of the PMA takes into account more of where the real trading happened across a different period, not just the average of each close
[...] I mentioned in the article on Pimp Moving Averages, any one candlestick or indicator can’t be taken in isolation. That’s my belief, and I [...]