I have joined this group about three weeks back. I am new to this group as well as to the field of Technical Analysis (TA). Of late, whenever I am logging into this group, I am being reminded that I have not posted any messages. But during these three weeks I have been browsing through the messages and trying to learn from the posts by the senior members. Now I decided to upload my first post.
Out of the various posts and discussions I browsed, the discussion on 'Moving Averages Trading System' started by TradersEdge attracted me. The reason is the moving averages method is simple to understand and implement. To do calculations and even to draw the charts it does not require any sophisticated software. In fact I do not use any specialized software at present. I perform the calculations and draw the charts using MS Excel Spreadsheet program. Later when I get some better understanding of TA I may look for a dedicated software package. With this introduction I come to the present topic.
I have gone through all the 108 posts on this topic and I am putting down few points which I have understood. I request the senior members and stalwarts in the field to give their opinions, suggestions and criticism so that my understanding improves. As the matter I want to post is quite large I decided to do in three or four parts. I will post each part with a gap of one or two days between each so that I get feed back before the next part is posted.
As has been clearly mentioned by several members who participated in the discussion on the topic of 3-13-39 methodology, the MA indicators are lagging indicators, for that matter almost all the indicators are lagging type. So the Buy/Sell signals are generated a little late after the event which triggers the significant price change. Therefore, the effort should be to use a strategy which minimizes this delay.
The Simple Moving Average (SMA) strategy has two drawbacks: 1) The values used in calculation of SMA have their effect only for the duration (period) over which the SMA is calculated. Thus for a 5-day SMA, today's price is effective for only next five days starting from today. 2) The effect of the price included in the calculations has full and equal weightage over the period of calculation. Due to this some times we miss the opportunity to enter/exit trades which would have been profitable. Although no trading system is 100% profitable we should evolve a strategy to maximize the profitability.
A chart was included in one of the posts to illustrate the 3-13-39 system. But that chart had initially a range bound price movement and then the down trend. I would have liked an example where all three types of trends viz. up trend, down trend and range bound movements were present.
To illustrate the above mentioned two draw backs of SMA and the resultant effect, I have included here a chart as an attachment. (TataSteel.pdf) Please see the chart and follow my explanation given below.
The chart is 3-13-39 SMA for TATA STEEL (NSE prices) for the period 1-1-2005 to 30-6-2005. The Green Line is 3 day SMA, the blue one is 13 day SMA and the red one is 39 day SMA. This chart has all the three types of price movements in it. The price is increasing from mid January to mid March and then falls till beginning of May and then till end of June there is no much movement in price. By applying the cross-over strategy we can find the points of entry and exit (Buy and Sell).
For the time being we will not look at the SMA lines but concentrate on the price bars. We can easily identify that there is a good opportunity to buy around 17th to 20th January, to sell around 14th to 16th March and again buy around 29th April to 2nd May. After that there is not much opportunity till 30th June. But we can infer this because the whole chart is available for evaluation. But in real situation we do not have it. So, we take help of SMA cross-overs.
The 3-13-39 system identifies the two later points with a little delay as the green line (SMA 3) crosses the red line (SMA39) in later half of March and end of May. But it fails to identify the initial opportunity in January. This point is highlighted in the chart with a pink circle. Here the green line just torches the red line and bounces back without crossing over. So we miss the opportunity here.
Now the question is why this happened. The reason is what I said above about the drawbacks of SMA. The closing price is falling steeply till January 14th and then it is almost constant between 14th and 19th Jan (Rs 344 to 348) As the 3-day SMA period is influenced by just three consecutive values the prices during 14th to 19th Jan nullify the effect of steep fall. Thus the 3 day SMA fails to give us the Buy signal.
This is already quite long essay. I would continue this later after a day or two. In my next posts I will describe some variations of the SMA cross-over technique which have less chance to miss an opportunity like the above. I will also take an example of trading and compare the gains/losses against the 3-13-19 system.
Meanwhile I request the members to freely express their opinions, suggestions and correction in this post. I apologize for the length of this message but I wanted to clearly bring out the points so that people like me who are new to TA can easily follow.
Till then Happy Trading.
-Anant
