Moving Averages and Trend Following

Submitted by Gold Stock Prophet Blog

In the previous two posts, I mentioned that the short term trend for gold was down, and because of this fact, I was holding a short position. The following daily Renko chart illustrates how I define what the short-term trend is:

The above chart shows how I traded gold this summer. The yellow area is where the short-term trend was up, the white area to the right is where the trend was neutral, and the orange area is where the trend was down. As you can see, the trend has rotated from down to neutral at this time.

I did not anticipate the severity of the correction gold and silver faced these last few weeks. However, by using the above technique, it was possible to be on the right side of the market for the majority of the move down.

I received quite a positive reaction to the article I wrote on August 6th that described how to trade with Renko charts. One concern though was that Renko charts are uncommon, and you need to be a subscriber on Stockcharts.com to access this charting style. Fortunately, you can create a similar result by simply using moving averages.

Below is a daily candle chart of Canadian financials:

One can use moving averages to determine if a sector is in a bull or bear market. The above chart is in a bear market, and this is evidenced by:

1) The 50 day moving average (dma) is below the 200 dma
2) The 50 dma is trending down
3) The 200 dma is trending down
4) The price is below the 50 dma
5) The price is below the 200 dma

Because banks are in a bear market, you must avoid going long, and focus on short selling weakness. One technique for short selling weakness would be to sell short whenever the sector falls beneath the 50 dma, and covering when the sector rises above it.

There is no one correct technique for trading using moving averages. It is more important to find a technique that matches one’s trading style. It is possible to develop techniques where the objective is to capture large swings that can last months, or to develop techniques that are designed to capture daily fluctuations. But in order for any technique to be successful, it must embody the following rules:

• Buy strength in bull markets
• Short sell weakness in bear markets
• Avoid getting involved with weak counter-trend moves
  
• Cut losses short
• Let winners run
• Separate emotions from decision making
• Avoid trying to predict the future

The above chart of financials is in what I would consider a classic bear market. However, it is not always easy to find such perfectly defined trends. One way to help is to use stock screens to scan the market for trends.

The scan looks complex, but is actually very simple. The above scan is simply screening the market for stocks that are below various moving averages, just like in the aforementioned financials chart.

The above stock is in similar shape as banks are in. This stock could turn around tomorrow, as anything is possible, but the I way I feel is that at any given point in time, a trend has a greater probability of continuing than it does of turning around.

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