Moving Averages are placed on various data bars including Candlesticks.
They show the current average, for a specified number of bars back, from the most current bar. One could use any facet of the data bar as the key for analysis. I use the Close of a selected number of past bars. One would add the closes, and then divide by the number of bars selected. This gives the average close of the bars. One can then draw a line showing the evolution level of the average. When a new bar is added, the first of the preceding group is dropped for calculations. The moving average line stays continually, and shows how the market is advancing.
The Three Moving Average Methodology is by far and away the most important indicator I have found and used. Moving averages have been used since the beginning of trading. They are an aid in determining momentum. The steeper the moving average is the stronger the momentum. The drawback is, they are lagging, as they are using prior periods for calculation. This means the Market may have turned or reversed before the MA tells! To use them effectively, one must really shorten their length. Then one gets too much “noise” or volatility. This leads one to “churning”, getting in and out quickly, taking too many trades and probably mostly losers. To eliminate these problems of moving averages, some use 2 or3 moving averages together. It is the cornerstone of my trading system and will help to override any other tool. If I could only use one tool for trading, a 3 EMA method would be it. It is head and shoulders above all the others, I have tried, and they are too numerous to mention. The 3EMA system is extremely helpful in entries, staying with and exiting a trade!
I have found my choice of lengths for the three moving average system to be extremely effective. They are the 3, 5, and 13 periods. We will also use
exponential moving averages. They give a very slight edge above the regular moving average. It puts more weight on the most immediate preceding bars. It is designated as EMA. The 3 and the 5 period EMAs are very short in duration thus producing little lag. The 13 period EMA does produce lag, but it smoothes the volatility. This helps establish the momentum for the bars being analyzed. Some may use a 15 period EMA, but I prefer a 13. It is a little shorter, and is a Fibonacci number.
In summary, we have eliminated a good deal of lag, but smoothed the volatility for basic momentum determination. The 13 period establishes the momentum for the chart. If it is flat, on any of the charts used for analysis, there is no momentum.
One should not be trading at that time. This system is almost magical. The 3 and
63 the 5 EMAs show immediate momentum strength and direction, by the steepness angle as well as by separation between the EMAs being used.
There is a term “Trading Price Action” This means trading what the market is actually doing at any instant. I have seen this 3EMA method, is as close to true price action as one can reasonably trade.
I have traded this method, without the Candlesticks or other indicators, and it is quite effective. I made the price bars black, so I had nothing to see, but the EMAs.
However, using Candlesticks and additional tools is much more effective.
Here is a chart below showing a 3 EMA Setup with the Candlesticks.
Some say Richard Donchian was the developer of the three moving average system. Some call him the father of trend following trading. I have not read his books so this is my way of using a 3 EMA system. In addition to being great for entries, it is the best “stay with” indicator and the best exit indicator, I have found in all my years of trading!
The basic concept, of a single moving average, is that one should be long when the midpoint of a price Candlestick is above a Moving average line, and short, when the midpoint of the price bar is below the Moving Average line. The longer the EMA period used, the more the line will be away from the midpoint of the
64 price bar. This can be vague at times with the shorter moving averages, so many simply use angle steepness to determine if momentum is moving up or down.
In the chart below left, I have shown two moving averages. The shorter period of 5 is in blue, and a longer period of 13 is the purple line. This shows up
momentum. The chart below right shows down momentum. Both are shown to clarify the concept of trading with a single moving average, not a two EMA system methodology. I have used different colors than I regularly use, for clarification of a single EMA system. One can see the shorter period EMA is closer to the Midpoint.
This chart on the left shows the shorter EMA is slightly below the midpoint of each price Candlestick. The longer EMA is well below the midpoint of the candle stick.
Both meet the criteria for a long position. On the right above, the shorter EMA is definitely above the Candlestick midpoint. The longer EMA is even further above the Candlestick price midpoint. One’s temperament would suggest which EMA to use. This could be determined with a great deal of screen time. In any case, a single moving average can be an effective tool. The EMA, of a single moving average, is an aid in determining whether to be long or short.
Notice in the next chart how close the 3 EMA is to the midpoint. This captures true price action as the slightest variation up or down is seen immediately. By itself, it would not be effective for trading, as one would be whipsawed in and out of trades.
65 The concept, with two moving average lines, is to use both a crossover, and price position relationship. Two EMAs gives added strength to an analysis. If one is in a long trade, the shorter yellow EMA will be above the longer orange EMA, and both will be below the midpoint. We still follow the same concept of midpoint to the line position. The benefit of the second EMA is giving an additional entry and Exit Signal. When the shorter EMA crosses below the longer EMA, an exit could be taken. A short entry could be placed as well.
This is seen in the chart below. In the red box, the yellow shorter 3 EMA crossed below the longer orange 5 EMA. The midpoint of the price Candlesticks is
generally below the EMAs, so one could short or sell. The angle is shallow however showing momentum is weak.
In the green box, the shorter EMA crossed above the longer EMA. The EMAs are generally below the Candlestick midpoint, saying one could go long. Notice also, the angles of the EMAs are steeper, than in the red box, saying momentum is stronger.
Even when there were white DOJI Candlesticks, and a red candle stick at the white arrows, the 3 didn’t cross below the 5EMA. This says don’t exit, stay with the trade. One can see, adding a second EMA gives a stronger verification of the immediate momentum. The crossover gives stronger confirmation for a trade entry or exit!
66 The next chart below shows the complete EMA system with a 3, a 5 and a13 EMA. When the 3 is below the 5 and the 5 is below the 13EMA, there is a down momentum. When the 3 is above the 5 and the 5 is above the 13EMA the
momentum is up. Please note this is for momentum, and doesn’t by itself establish a trend! However, a momentum as determined here is tradable.
Again, a cross of the 5 EMA by the 3 EMA is a warning of a possible momentum change. If one were in a trade that would be an Exit Signal. The crossing of the 13 EMA by both, confirms a momentum change. If in a trade it is a failsafe exit. It could be an entry for a subsequent trade.
Remember, if the 13 EMA is flat, one should not be trading as there is no momentum. Keep in mind, the steeper the angle, the stronger the momentum. A steep angle is a must for trade success. Also, one must be sure there is good separation between the EMAs. There should be a larger separation between the 5 and the13, than the 3 and the 5 EMAs.
67 The 13 EMA is like a line in the sand. On the Trend Chart, it determines the basic momentum. It is a Support - Resistance level to be discussed. If price is above it we are looking for longs. If price is below it we are looking for shorts.
Similarly, if the 3 and the 5 are below the 13 EMA, we are looking for shorts. If the 3 and the 5 EMAs are above the 13 EMA we are looking for longs.
A change in the direction of the EMAs, on the Trading Chart, could be a pause, a Pullback, or a rally, before returning to the basic momentum of the Trend Chart.
The 13 EMA on the Trading Chart establishes the immediate momentum. A cross, of the shorter EMAs, could be an alert for direction to change on a Trend Chart. Of course, the Trading Chart could return to the Trend Chart direction. If one were to enter a trade opposite the Trend Chart, it would initially be a Countertrend Trade.
It might prove to be a trend reversal trade in time. It is important to note again, trades should only be taken at Alert Levels.
If the EMAs, on the trading and Frontrunner charts change direction, one could look to see if the EMAs are leveling on the Trend Chart. If they are, then the immediate reversal on the shorter term charts could be a start of trend change.
If the Trend Chart has a 13 EMA, that stays flat for several bars or more, it is a stand aside signal. There will probably be congestion in the Trading Chart. So, price may be erratic and signals will have little follow thru. In the 13 minute chart below on the left, the white 13 period EMA stayed relatively flat for 90 minutes.
During the same period on the 3 minute chart to the right, price stayed in a trading range. This could have been scalped, taking 2 or 3 ticks shorting at the top white line, and buying on a bounce off the bottom white line, but it would be risky.
68 A summary of the basic concepts regarding the 3EMA system include the following:
When the 3 crosses the 5 EMA and then the 13 EMA a momentum cycle is initiated.
When in a long trade, the 3 crossing below the 5 EMA is a signal for at least a minor momentum change, and probably an exit. Both crossing the 13 is probably a momentum change and a definite exit.
The strongest trend is when the EMAs are steep. A good separation between the 3, 5 and 13 is ideal. A leveling of the 3 and 5, but not crossing, shows pause in the momentum. When the 3 and the 5 resume momentum, it is a continuation entry signal. One should never, ever enter a trade if the 3 is against the trade direction.
(As an aside thought, the 13 EMA is used both for the Moving average system and the Blau Oscillator Method to be discussed next.)
The 3EMA System uses Sub Chart 1 only.
The 3 EMA line is yellow, the 5 EMA is orange, and the 13 EMA is white.
At the yellow arrow, the 3and the 5 EMA moved above the 13 EMA. This says a new momentum is starting up.
At the green arrow we get a bar with a close above the 3 EMAs. This would be an alert to go long and is called the Signal Bar. There was good separation between them.
If the 3, 5 and 13are almost or actually touching, as seen before the yellow arrow, there is indecision.
Thus, it is a sign to stand aside. If in a trade it says to be very cautious and consider an exit.
At the top, at the white Doji STRB, marked with the red arrow, the 3 and the 5EMA turned abruptly down.
This confirms the Doji statement; the Bears have taken over. This would be a signal to exit the long trade.
At the purple arrow, the 3 EMA again turned abruptly up. This is an Exit Signal if one had taken a short position. It also says, price may resume its upward momentum.
69 The 3EMA System
At the bottom green
Candlestick to the left, at the green arrow, the 3 and the 5 EMAs turned abruptly up.
There was fair separation between the 3EMA and the 5.
There was good separation leveled. This is a time to tighten Stops or exit. If the 3 EMA crossed below the 5, that would signal a definite exit. It never closed below the 5 EMA here.
When the 3and the 5 EMAs turned up again, at the yellow arrow, it said to stay with the trade. If an exit had been taken, another long could then be taken.
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