When you are first exposed to the concept of technical trading (making trading decisions based on price chart patterns and price movements), most people will think they have finally found a sure-fire way to make money in the markets. The running joke is that technical traders are searching for the “Holy Grail” in their trading – ie they are looking for that perfect combination of price movement, chart patterns, and chart indicators that will always result in a profitable trade and never give a false signal.

Of course just like in real life, the search for the Holy Grail in trading is never ending. In other words, there has never yet been a system discovered which would always result in profitable trades and never give a bad signal.

One of the most common, and indeed still the most useful, types of chart patterns to study is the moving average (abbreviated MA). A MA is simply a curve that represents previous price action that is usually plotted directly over the price chart. If you were looking at a MA curve on a daily price chart (one price bar per day), each MA chart point is the average of “X” number of days’ price points added together and then divided by “X”. This gives you the average price for that number of days. The first MA chart point cannot be plotted until “X” days have elapsed, and then each successive chart point is plotted after that. The starting day for “X” is bumped up one price bar each day, so that every point on the MA curve represents the latest “X” days. This is much easier to see than it is to describe!

The resulting MA curve follows the price bars somewhat, but a larger “X” produces a more gentle MA curve, (and further removed from each day’s price action). A smaller “X” number produces a MA curve that is a little choppier and more close-fitting to the underlying prices.

A MA can be plotted for any desired time frame, not just for daily charts. Some common price charts day, hour, 15-minute, 5-minute, 1-minute, and tick data. There are also weekly, monthly, and yearly price charts. It really doesn’t matter the time-frame of the chart as for as a MA is concerned. The MA is simply calculated based on the default period for the chart it is being plotted on. Almost all charting programs have some type of MA-plotting capability, but the more expensive charts usually give you more options and more ways to vary and adjust the MA curve.

Traders usually use more than one MA curve per price chart, and make trading decisions based on when the MA curves cross each other. A slower-moving (ie larger “X”) MA if crossed by a faster-moving (ie smaller “X”) MA on the upswing will often coincide with the beginning of a price rally.

Every major up or down move in the market will be signaled by some type of MA curve crossing. At first glance this looks like a tremendously profitable chart indicator and the beginning trader will probably think he has indeed discovered the Holy Grail the first time he sees a chart full of MA crossings that point out where he could have bought or sold for great gain. The problem with MAs is that the curves will also cross when the market is merely moving up and down in a “trading range”. (A trading range looks kind of like the teeth on a saw – a repetitive cycle of ups and downs that never really go anywhere). The trader who only trades MAs will get creamed during a trading range as he is constantly buying, selling, and losing money. Indeed, he will most likely lose any gains he had made during the big price action moves.

So even though MA curves can certainly give us some good idea of market direction they must be used in conjuction with other chart patterns or trading signals to try and improve the reliability of spotting just the major moves, and not getting caught up in the trading ranges. But MA curves are always useful in helping to confirm the price trends and that is how most traders end up using them – as confirmation signals of other pattern indicators and not as primary signals.

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