Ask Colin

How do I decide the time period to use for a moving average?

There are many theories about how you decide on which moving average to use. Some people use a number of days that relates in some way to a cycle length. Others use Fibonacci numbers or other "magic" numbers. Some people even try to "optimise" the length of the moving average, by testing a range of moving averages over past price data. This is dangerous, because it can easily turn into "curve fitting" - a result that is too specific to the data used for testing. In the end it comes down to two things:

1. The length of your moving average must relate to the time frame you wish to trade. If you are a day trader, you will use a much shorter average than a short-term trader. A position trader will use a longer average and an active investor will use an even longer one.

2. When you settle on a length for the moving average it should not be too specific. In other words, you can move a little longer or a little shorter and the results are about the same. This is what is called "robust" in the trade.

The other aspect is that everyone should study charts starting with determination of the long term trend, moving down to the medium term trend and lastly to the shorter trends which they are actually trading.

I tend to use a 260-day (52 weeks) moving average for the long-term trend and a 150-day (30 weeks) moving average for the medium term trend.

However, my friend Dr Alexander Elder uses a 130-day (26 weeks) moving average for the medium term trend. I am leaning more to this lately. We both use a 22-day (4 weeks approx) moving average for the short-term trend.

A day trader would use a shorter average, and on intra-day price data.

When placing your moving average on charts, you will soon see that they look really useful on some charts and not good on others. The latter are usually the stocks that are too volatile (don't trend well) or too sluggish. Discard them and work with the ones that seem to move in good trends and at a rate that allows you to profit from the moving average.

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