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That's it: a simple trend-following indicator that works. Figure 1 shows the Dow Industrials and this indicator over the last 14 months with the buy and sell signals identified. Note how the cursor will help you identify actual crossovers by showing the value of the indicator and the value of the moving averages. Figure 2 shows the same information but only for the last seven months. Blindly following canned indicators can lead you into a false sense of security.

An additional technique to help avoid or reduce whipsaws is to construct a trading band around an arithmetic moving average that uses the same period as the buy/sell average discussed above (21 days). This trading band is on the price action itself and the percentage for the band is one that will encompass most of the data or at least 90 to 95% of the data. The best buy and sell signals occur when the price action is at or near the limits of the trading band. Obviously, buy signals should be accompanied by price action at or near the lower band and sell signals at or near the upper band. If it is near the center or near the opposite side, you ignore the signal given by the oscillator. If the price action is outside of the trading band, the signal is probably premature. That's the nature of momentum and is another subject entirely.

Figure 3 shows the Dow Industrials with trading bands of 4.5 percent on the top plot and the indicator with the new buy and sell indications at the bottom. Note that the indicator plot was changed to just a line plot instead of the histogram plot as shown in Figure 1. Again, the last seven months are shown for better detail (see Figure 4). Notice the reduction of signals when applying the trading bands to the system. Remember, determine the dominant cycle. Select the short exponential average equal to one half of that cycle. Use a longer term exponential average equal to six times the short one. Then place an arithmetic moving average over the difference between the two exponential averages. The length of the arithmetic average should be three times that of the short exponential average. Use trading bands to help filter out some of the whipsaws. Whipsaws are a fact of life in a trend-following indicator--accept them and you will always be on the right side of the market. If you start with a series of small losses, you will really get excited when the big moves come.

I have prepared a small list of parameters that I have discovered to be the best (so far) when utilizing this technique. The first number is the short exponential average, the second number is the long exponential average, and the last number is the arithmetic moving average used on the oscillator and for the trading bands.

Selected Parameters

Just to show you that this can work elsewhere, Figure 5 shows a sell signal just before an 11.88 point drop in the S&P 500 in September 1986.

These are just a few examples of the parameters what I have found to be fairly reliable. As a stand-alone indicator, this one works quite well. However, if used with a basket of indicators, overall results improve significantly.