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Moving Averages as Support and Resistance

Another approach to the use of MAs is to use them as measures of supВэport and resistance. Generally defined, support is a price level from which the market is expected to recover should it decline following a price rally. Resistance is a price level from which the market will decline following rallies in a declining trend. Support is used for the purpose of establishing long positions on price reactions or corrections during risВэing markets. Resistance is the price level used to establish positions on rallies during bear trends.

Throughout the history of the stock and futures markets, there have been many efforts to specifically define support and resistance levels or areas. Each school of market analysis has developed its own methodoloВэgy. Chartists point to certain formations, trend lines, and price-versus-volume patterns as their preferred methods of establishing technical support and resistance levels.

Point and figure chartists have their unique methodology as well. And, of course, those who adhere to the teachings of Gann and Elliott use percentage retracements and Gann angles as their preferred methods of establishing support and resistance. While I do not discount the validВэity or potential of such methods, I find them too intricate. I have develВэoped my own approach which has served me well during the years. The sections which follow illustrate some of these ideas and techniques.

Dual MA Crossover for Support and Resistance

This approach is a very viable one for day traders, and I recommend it strongly. Its assets are clearly that it provides a specific entry point either long or short and that it is relatively simple to use. Its downside is that it is not an entirely objective or strictly mechanical methodology.

Applications of Intraday MA for Support and Resistance Trading

The application of this approach is very simple indeed. There are basiВэcally three steps involved:

Вц Use the dual MA crossover method. The 8:1 ratio suggested earlier should be used.

Вц Determine market trend. This is accomplished by examining the price chart for the last crossover signal. If the last crossover signal was a bullish signal, then the trend is assumed to be up. If the last crossover was a bearish signal, then the trend is assumed to be down. Please consult Figures 4-6 and 4-7 for specifics.

Вц Buy on price declines to the longer of the two MAs which serves as support and sell short if the trend is down on price rallies to the longer of the tw.o MA lines. Again, please consult Figures 4-6 and 4-7 for specific illusВэtrations of this approach. In any case, you will close your position, win, lose, or draw, by the end of the trading session.

Since there is no way to determine whether a decline to the MA line in a bullish market is the start of a new trend down or just a reaction on which to buy, you will need to protect your position with a stop loss.

Stop losses may be determined in any of several ways as previously discussed.

You may use a strict money management stop, in other words, risk a fixed dollar amount on each trade or you may use a specific technique for stop loss placement. The money management or dollar risk stop is self-explanatory; however, I remind you that larger stop losses are often preferable to smaller stop losses, since markets do need room to negotiВэate their moves.

In terms of time frame, I recommend using between 5-minute, 10-minute, or 30-minute data. Anything shorter than 5 minutes would be too short, and anything longer than 30 minutes would not allow for sufВэficient time before the trading session ends.

In Summary

In the final analysis, I recommend against the use of MA systems for the purpose of day trading. Although there are variations on the theme of moving average (to be discussed), the vast majority of methods do not yield much more than losses and commissions. Avoid these systems since they are not likely to serve you very well. The use of MA systems, however, with support and resistance as trend indicators, does have good potential, but it is difficult to subject to a rigorous test.