MOVING AVERAGES

Moving averages, or MAs, set at the right parameters, can serve as an excellent means of containing a stock, or market, in a strong trend. The moving averages that do the best job are the 5, 15-, and 39-period simple moving averages (see Chart 2.1)

Various software programs allow you to perform this simple function. Using the three specific moving averages in the One Shot – One Kill Method gives you a strong, viable weapon in trend delineation for making your trades.

The purpose of using three different moving averages is sim-ple. Each of them serves an important role in quantifying short, intermediate, and long-term trend. The five-period MA does a good job of letting you know where the short-term trend is. You can look at it and instantly know whether the market is getting weaker or stronger, in the shortest time frame you allow yourself to trade. This can be applied on a three-minute or a daily chart.

Pay close attention to the 15-period simple MA, calculated from the close of the bar. It has an uncanny ability to match up with Fibonacci retracements, and serves as an excellent spot for a pullback to find support or resistance and resume in the direc-tion of the trend. The 15-period MA frequently allows traders to reenter positions after they have already gotten in the move.

This safe yet simple method for getting into the prevailing trend allows users to benefit from low-risk, high-reward trades. The 15-period simple MA is comparable to the 20-period exponential MA, which accomplishes basically the same thing. I encourage you to use either one, as I have found in my experience the dif-ference between the two is nominal.

As Chart 2.2 shows, Taro Pharmaceuticals’ new division, TaroPharm (TARO), is breaking out, and some might even con-sider it to be getting ahead of itself. Using the One Shot – One

26 Phase I: Basic Trading Tactics

CHART 2.1 Assessing whether or not to buy weakness or sell strength is done largely by using the 5-, 15-, and 39- period moving averages. If the vehicle you are trading is above these respective moving averages, the bias is toward buying weakness, whereas if the market is below these moving averages, the bias is to sell strength.

Kill Method, you will not need to chase stocks or any other prices. One of the reasons is because you can use the 15-period MA to get a very good feel for when a pullback is in order and what numbers will act as support for the stock’s next run. Many stocks prices come near their 15-period MAs, as well as having Fibonacci areas of support underneath them (covered in Chap-ter 4), both of which can act as a good spot for a bounce. These are some of the things that are important for you to decipher.

One problem with moving averages, which you need to watch out for, is the propensity to get whipsawed out of trades, meaning the stock moves above the moving average and then below it, causing sell or buy signals too early. It is because of this tendency that no one indicator of the One Shot – One Kill Method should be solely relied upon in making a trading deci-sion. I have been whipsawed out of trades like everyone else, but I have also found that having a confluence of moving averages and using the other indicators I use will greatly increase the ability to make more successful trades.

The 39-period MA shows an example of the moving average containing trend the entire way down on a short position, from September 2000 to January 2001. The One Shot – One Kill Method uses a 39-period MA to quantify the trend in the time period you are trading. If you are swing trading a stock–that is, holding a position and owning it for three to seven days—then, you will want to see where the daily 39-period MA sits. If you are day trading, always be aware of where the 39-period MA sits for the sector and market, on an hourly basis. In order to recognize a trend change, the investment vehicle must have two succes-sive higher closes than the moving average. If it cannot do this, then you will consider the trend to still be in play until you reach your profit target. By using this objective means of adding to positions, you will eliminate emotion from the equation and allow yourself to increase your profits in a very logical, system-atic method.

The One Shot – One Kill Method uses the 15-period MA to set stops, which also serves as an excellent short-term gauge to tell you which way the trend is going. However, like most mov-ing averages, when you use them in nontrendmov-ing markets, there may be a propensity to get whipsawed out of trades.

28 Phase I: Basic Trading Tactics

CHART 2.2 The 15-period simple moving average usually provides low-risk entries on strongly trending stocks. It is at these areas that I look to enter a trade long on a pullback to a rising 15-period MA or short to a declining 15-period MA.

The application of the three different moving averages pro-vides an objective way to qualify short-term, intermediate, and long-term trends in any time frame as well as provide you a solid method for reentering positions, which are running powerfully in one direction. It is for these reasons I use these particular moving averages.