Custom Search

The Moving Average Channel

Borrowing from concepts originally introduced in the 1950s by Richard Donchian, I departed from the traditional use of moving averages. I conВэducted intensive research on moving average channels (MACs) which consisted of a moving average of high prices and a moving average of low prices. Rather than focus on closing prices, I felt that support and resistance should be determined using high and low prices, since high and low prices are specifically geared to ideas of support and resistance.

Typically, resistance tends to be found near previous highs, and supВэport tends to be found near previous lows. It therefore occurred to me that rather than examine moving averages of closing prices for support or resistance, it might be better to use moving averages of lows and highs to determine support and resistance respectively. What I discovВэered took me several years to fully believe and several more to impleВэment.

My technique uses a moving average of the high and a moving averВэage of the low in conjunction which form a moving average channel that is used for determining support and resistance. Figure 7-1 illustrates the MAC used on a 5-minute chart. As you can see, the channel has some distinct characteristics:

1. When the trend of prices is up, the MAC tends to act as support. In other words, as price declines to the lower portion of the channel, the movВэing average of lows (MAL) tends to find support.

2. When the trend of prices is down, the MAC tends to act as resistance. In bear trends, rallies to the top of the channel, the moving average of highs (MAH) tends to serve as resistance.

3. When price bars are completely outside the top of the channel, the price trend is strongly bullish. Please refer to Figure 7-1.

4. When price bars are completely below the bottom of the channel, the price trend is very bearish. See

Figures 7-2 and 7-3 further illustrate the relationship between the MAC high and low and prices. Please note that I have indicated support and resistance levels accordingly. Can you think of how these levels might be used?

How Support and Resistance Develop during the Day

Please examine Figure 7-4. It consists of several frames which illustrate how support and resistance patterns develop during the day in relation to the MAC. As you can see, prices tend to bounce off their support levВэels. The purpose of the channel is to define precise areas of support and resistance. In an up trend, the day trader will attempt to buy when price enters a support area and sell when price enters a resistance area in a down-trending market. The key is to specifically define the following:

1. The trend

2. Support and resistance