Wednesday, June 3, 2009

Why I Use Exponential Moving Average; and an Update on the 20 Day Moving Average

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I often get asked why do you use exponential moving average versus simple moving average. I have no good reason other than "it works for me". I think more people use the simple moving average just from speaking to so many traders over the years, and frankly much of the time - especially in slow moving markets or with slow moving stocks - there is little difference. Also the lower the number (shorter the time frame) the less the difference... it usually only matters at 50 days and above.

The reason I bring that up is because now is one of those points where there is a large difference in the exponential versus simple 200 day moving average on the S&P 500. I find it striking in fact because in my world, the S&P did not break the 200 day moving average. Although that is all I heard Monday... and since so many people use simple, one must respect the 200 day was "broken" cleanly if that's the playbook the crowd is using.

Let me show you the difference between the two

This is my world... I saw the S&P 500 surge, not break the 200 day (on a closing basis, only intraday) but in fact touch it 2 days in a row... and then get rejected.

EXPONENTIAL MOVING AVERAGES


This is what most other people are seeing - the S&P 500 surging through the 200 day and hence technical traders were sent a signal to pile in.

SIMPLE MOVING AVERAGES

What is ironic, is "my method" said while there was a breakout over the S&P 930 level (which was important as it was previous highs) we got slammed back at the 200 day moving average. I had mentioned earlier this week I was scratching my head because so many things seem out of sorts - the fact we could break through such a key resistance line as the 200 day in just 1 try just does not make any sense historically. But we did... at least in a simple moving average world.

Now in a strange situation, on the 200 day simple moving average ... it has such a sharp slope that on Monday it was up near 930 and today its down to 923. Which is right about the low of the day... the technical book says after a resistance area is broken, you want to buy the pullback to that resistance, as resistance is the new support. But usually it's the same number (or very close) i.e. S&P 930. But in 2 days that number has fallen 7 S&P points... since 200 days ago we were in a vicious sell off of fall 2008... hence this moving average is plummeting.

So it is setting up one interesting dynamic - and 2 different stories depending on whether you're a SMA person or an EMA person. I guess depending on what sort of technician you are - you are living in a different parallel universe right now. It's quite a bullish spot to buy if you are a simple MA folk, but not so much as an exponential MA folk.

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With all that said, we've been saying for weeks the 20 day moving average has been the markets line in the sand. Everytime it is threatened a magical flood of futures orders comes in the market... billions upon billions from "somewhere". I just want to update you on that number... its now up to 908 ... just last week it was below 890.

So in the near term, I am not really sure here because I see 2 stories - but until we cleanly break that 20 day moving average ... AND we don't see a flurry of futures orders some day at 3:58 PM to change the story (i.e. last Friday)... we have to assume the rally is still on. Because... so much money is trading on hope and squiggly lines...

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