Ask Colin

I am tracking the daily and weekly moving averages on a stock I bought, but they are giving different signals. How do I use them to exit the trade?

What you are asking is really an expression of the common problem of time frame. This is a difficult area to master, but is critical to trading effectively.

Before I tackle it, I need to say something else. Your question rather implies to me that you do not have a trading plan with clear strategy on time frame and clear exit rules. This is one of the main reasons why most beginning traders fail. You may find some benefit from the videotape of my seminar that I am selling on my web site.

Now, the moving average question is surprisingly simple. It is the psychology of decision making that is the difficult part. This also comes back to the trading plan, because if we do not have clear tactical rules, the decisions will always be difficult because we do not have clear guidelines to reference the decisions to.

The weekly moving average tells us the direction of the medium term trend. So, if we are trying to trade the medium term trend, we will take our buy and sell signals from the weekly moving average and ignore the daily moving average.

However, if we are trying to trade the short term trend, we will take our signals to buy and sell from the daily moving average.

This does not mean that we ignore the weekly moving average if we are trading the daily moving average. One of the important insights in technical analysis is that short term trends are influenced by longer term trends. So, if the longer term trend is up, the rallies will be stronger and last longer than the corrections in the short term. The same applies in reverse for a longer term down trend, the corrections will be stronger and last longer than the rallies in the short term.

So, what a short term trader must do is to trade the daily moving average, but only in the direction of the weekly moving average. So, if the weekly moving average is sloping up, we take buy and sell signals from the daily moving average, but we only trade the long side of the market, we do not sell short.

The same applies with a medium term trader who is trading the weekly moving average - we should in this case only take signals in the direction of the monthly moving average.

If you did not appreciate the significance of the reference to trading "long" side of the market and "short" selling above, see the article on the Articles page of my free access web site www.bwts.com.au

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