Ask Colin

In different places, you have written to use a 260-day Exponential MA, a 260-day Simple MA, a 12-month MA and a monthly MACD. Which is correct?

They are all useful. There is very little difference between any of the three MAs. The MACD is a bit different. Let me explain.

There is a perennial argument about exponential versus simple moving averages. They have pros and cons. It finally comes down to a judgement call, depending on what aspects you think are most important to you. Different traders and investors may legitimately come to different conclusions. I think the argument is far more relevant to short term trading.

There are two things to understand about how I use them. One is that the period is long - 260days, 52 weeks, 12 months, whichever you choose to express it as. The MA therefore does not move sharply. One of the advantages of exponential MAs is that they are more responsive to recent prices. This is not critical for me.

The other thing to understand is that I do not trade off the moving average. I only use it to give me broad trend direction when I am selecting interesting charts. The detailed shape of the line is not relevant - only its general direction and shape.

On the subject of 260-days versus 52-weeks and 12 months, they are all essentially the same. There are minor differences because the first uses 260 daily closes in its calculation, the second uses52 weekly closes in its calculation and the last 12monthly closes in its calculation. The difference then is the data you use to calculate them. In some software you may not have a choice. You might only ever be able to do a daily moving average. However, in other software, you can use compressed files so you have weekly or monthly data.

The monthly MACD is different in two respects. Firstly, you must use monthly closes for the calculation of monthly MACD. Hence 26/12/9 monthly closes. I suppose you could adapt the parameter to use weekly or daily closes, but I don't see the point. I just compress the file to monthly (one keystroke) and I have it using the standard defaults. That is also why I use 12-month MAs in that case - I have a monthly file.

The second respect in which the monthly MACD is different is that it is an interesting, but minor part of my method. It was excellent in the bull market to give you a final warning bell that the long uptrends of the 1990s had finished. If you saw the monthly MACD cross down, and you still held the stock it was a wake-up call. It can work the same way after a long downtrend, but there is a basic flaw in it because a long slow downtrend can produce a rising monthly MACD in buy mode. However, when this flaw is not evident, it can be a useful way to quickly scan a lot of charts for interesting stocks, either visually or by an automated database scan.

Keyword: