Technical Indicators IV- Forex Trading

The given chapter is dedicated to the problem of Moving Averages (MA). It is one of the principal indices at Forex. In their book “Computer analysis of future markets”, Ch. Lebo and D. Douglas state that the greatest sums of real money are earned by making use exactly of the MA index. Even taken together, all other technical indices are less helpful. This is true. However, Ch. Lebo and D. Douglas have not mentioned that 19 of 20 traders do lose their game when they mainly use this index (MA).

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Here I try to expose the origin of such a high rate of losses and losers (19 of 20 traders!). The losses are caused by a somewhat simplified approach to the utilization of this so important technical index by “classicists” of Forex. The analogous view on MA index is inherent in the up-to-date analysts as well. Further, traders do the same. However, for the latter misunderstanding of the analytical approach to MA results in losses of real money at Forex.

Take a look at the charts submitted by J. Murphy in his book “The technical analysis of future markets” (Part 9). There plots are keep on “migrating” (roaming) from one manual of Forex to another.

Chart 14.1. There is an example of combination of the 10-days simple MA (SMA) with the 40-days one. The reader should pay attention how accurately the tendency in price movement is repeated by the short 10-days MA. The 40-days MA is behind of the price movement somewhat farther. MA value evens up (levels) the spread of prices. At the same time, these MA are always keep on being behind from the market dynamics in time. The 10-days MA is designated as the solid line; the 40-days MA is presented in the form of the dotted line. (For view picture see notes in end of article)

Chart14.2. There is an example of the 20-days simple MA. Traders regard intersections of MA curves by prices as signals for opening the corresponding positions. In the period that corresponds to the chart right border, the price indices are below the MA curve. This indicates that the market is at the stage in decline . One should pay attention to the following fact. The 20-days MA curve evens up the price dynamics. All the same, this 20-days MA curve is keeping behind from the market dynamics in time.

(For view picture see notes in end of article)

According to these pictures, everything is clear – isn’t it? That is, at a certain point one must stake on “sell”, at another point one must stake on “buy”, etc. Probably, looking at this chart, any beginner could think that his account would be doubled after several days of the work at Forex. However, in fact, just 1 of 20 traders does earn his money. At the same time, all traders (19 losers included) make use of MA index in this or that form during their work at Forex.

Hence, one must get to learn how to make use of MA in order to gain profit but not to sustain damages.

First, let us examine the problems concerning MA. One must understand the reasons why the majority of traders lose their money when using MA. After this, one must find the way-out.

The problem #1. Which charts the classicists of Forex do not include into their manuals.

Let us scrutinize the graphs given below. After this, you can clearly understand why 19 of 20 traders leave Forex for good.

Chart 14.3. From March 24 till April 16, 2006, in EUR/USD pair movement the 10th and 40th MA intersected one another 11 times. (For view picture see notes in end of article)

Chart 14.4. From January 13 till February 3, 2006, in USD/JPY pair movement the 10th and 40th MA have 12 times intersected one another. (For view picture see notes in end of article)

Chart 14.5. From February 16 till April 16 of 2006, in GBP/USD pair movement 10th and 40th MA have 13 times intersected one another. (For view picture see notes in end of article)

Chart 14.6. From March 14 till April 7 of 2006, in GBP/USD pair movement 10th and 40th MA have intersected one another 9 times. (For view picture see notes in end of article)

The conclusions are the following.

Here we deal with a flat. In contrast to the trend, in a flat MA don’t “obey” the rules submitted in the classical manuals. Rather on the contrary, when a faster MA intersects a slower one, it can be a sign of an imminent reversal. Respectively, a deal must be open in the direction opposite to the MA opening. Such a situation is typical of a trend within the time frame (TF) smaller than a flat within a larger TF.

Conclusions.

· One must not regard MA separately from the flat and trend – how it has been done in all classical manuals of Forex.

· As regards the duration in time, a flat is longer than a trend.

· First of all, you must learn to clearly distinguish the moment of the flat finish (end) from the start of the trend. Only after this you may open a real account at Forex. Otherwise, you will lose your money – as it does happen to 19 of 20 traders.

The problem #2. Within what TF one should work with MA. Some classicists of Forex prefer D1 (DeMark). J. Murphy uses M5 (for the intra-day trading) and up to W1. E. Neiman and B. Williams use D1, W1, etc.

However, these specialists avoid answering the principal question. That is, what a trader must do when MA are reversed towards different directions in various TF.

· For instance, within M5 MA go upwards.

· Within H1 they go downwards.

· On the contrast, MA do come together in the chart H4.

A. Elder has partially explained this problem in his three-shield system. Advantages and drawbacks of this approach are examined in a separate chapter.

The problem #3. There can be trends strong or weak . Let us examine a trend of the simplest kind – i.e., the intra-session one (see the chart on February 13, 2006). To the participants of Masterforex-V Trading Academy, I recommended the following.

a). As regards the European session on February 13, 2006, I advised to make super-short deals on “sale” with GBP/EUR pair.

b). As regards the American session on February 13, 2006, I advised to make super-short deals on “buy” with the same currency pairs (GBP/EUR).

c). As regards the European session on February 14, 2006, I recommended to make a prolonged deal on “sale” (all over the trading session).

d). As regards the American session on February 14, 2006, I advised to make super-short deals on “buy” with the same currency pairs.

In any classical manual of Forex the criteria of the difference between the strong (heavy) or weak (feeble) trends are not pointed out. Consequently, the two advices to a trader can be given.

A). to “allow the profit to come in (to flow)” when the trend is strong (heavy).

B). to open super-short deals to gain the profit of 10-20 points because the currency pair movement is restricted, which is detectable during the very first movements.

This technique, when used in the daily trading in Masterforex-V Trading Academy, gives reasons to doubt the correctness of the statements made by Ch. Lebo and D. Lucas. In their book “The computer analysis of future markets”, the authors state that MA indices always indicate the trend direction. However, with MA one cannot estimate the trend strength (the heaviness or weakness of this trend). It is especially important if one estimates the trend strength with the help of MA indices, taken from other systems of Forex technical analysis.

Problem #4. MA index drawbacks exert influence on other technical indicators, based on them (MA). Therefore, such indicator will deceive a trader during trades even more than MA does it.

For instance, there are MACD (Moving Average Convergence/Divergence ), Alligator, Awesome Oscillator, CCI (Commodity Channel Index), Moving Average Envelopes, Moving Average of Oscillator, Bollinger Bands, Stochastic Oscillator, etc. All such indices are based on MA. When developing such indices, the authors issued from MA. Further each of them added to this basis what he liked. It could be the rate of change in the price, the trading volume, the closing price value with respect to the previous data, etc. Who has added what to MA does not make a secret. One can learn it, for instance, from MetaTrader software engineers from MetaQuotes Software Corp.

In this connection, there arise the following questions.

1. What for each author adds to MA a characteristic according to his own choice?

2. Why there are so many indicators and, consequently, their developers? Why an improvement, made by one creator, has not satisfied a subsequent author?

3. What a drawback is inherent in the notion of MA itself – so that they must be infinitely (and to no effect) be improved, being unusable in their original form?

Hence, a large number of professionals waste their time, understanding that the indices available are unusable. You can judge by yourself. Let us put oscillators at the foot (bottom) of the chart. One can pick them out of one’s choice – even all of them. In practice, all charts demonstrate the same. That is, each of newer designers has realized the drawbacks in the work of his predecessor. However, an original oscillator, developed by every new specialist, indicates the same data as oscillators developed by a previous author.

Problem #5. According to J. Murphy, the following approach is axiomatic in the framework of the classical Forex (see “Technical analysis of future markets”; Part 9). The point of entering the deal is the crossing of a slower MA by a quicker one. For instance, if MA #10 intersects MA #40 top-down, this corresponds to opening a deal on “sell”. I can give thousands of examples when the deal opening in accordance with this formula was too late. This can happen in the cases of the trend strategic/tactical correction – especially under the conditions of strategic reversals. Otherwise, the deal opening according to this formula can be erroneous (fallacious) – in a flat. The above-given charts illustrate some cases when the opening according to this formula is wrong.

Thus, a vicious circle becomes developed. On the one hand, the period length must be taken into account in order to exclude the “market noise” influence. On the other hand, one must consider the delay in MA as compared with real changes in the market. This problem is still unsolved.

· The higher is MA number (100, 200), the weaker is MA reaction to the “market noise”. At the same time, the delay in MA during reversals is more considerable.

· The smaller is MA number (5, 10), the more intensive is MA reaction to the “market noise”. That is, an ordinary (common) correction can be mistaken for a heavy and rash reversal.

Problem #6. For traders, improvement in MA results in consequences even worse. All theorists and traders acknowledge that MA are being late. However, methods in solving the given problem are imperfect (so to say, “middle-of-the-road”). For instance, instead of simple MA, the following improved versions are submitted:

* Exponential Moving Average;
* Smoothed Moving Average;
* Linear Weighted Moving Average.

There are individuals who prefer to change simple MA into exponential MA, etc. (they consider this to be the means of optimization this index). J. Murphy struck such “admirers” the heaviest blow. In “Technical analysis of future markets” (Part 9), he quoted a certain statistics. These data were initially submitted in the paper “Computers will help you in the game at future markets” by Hockhaimer in YB “Commodities”, 1978. There the analysis is given to effectiveness of different ??? (TA) in the period 1970-1976 at various future markets. The conclusion is the following. The simple MA is the most effective.

Ch. Lebo and D. Lucas arrived at the analogous conclusion. These authors admit that there is a seeming (apparent) refinement of weighted- and exponential MA. However, in practice, every test observed or carried out by them indicates decided superiority of simple MA to all others from the viewpoint of gaining profit. According to Ch. Lebo and D. Lucas, the application of exponential MA, as a rule, results in “jerking”, too costly for traders. This confirms the authors’ opinion. That is, if a method of entering the deal is based on obscure calculations, there are more negative consequences of its application than positive ones. The future trade is rather art than a science. The mathematical refinement of a method does not guarantee profits.

Such conclusions makes a true shock for those who neglect the problem of MA – for those who just prefer to replace simple MA by exponential-, smoothed- and linear-weighted ones. In particular, this concerns E. Neiman. The latter, in “Trader’s small encyclopedia”, persistently (strongly) recommends to apply the exponential MA (EMA). He states that simple MA to times reacts to one change in the course. Figuratively speaking, the simple MA (SMA) “barks” as a dog. For the first time this happens when a new value is received. For the second time the “barking” is heard when this value is quitted from the calculation of MA. As compared with SMA, EMA reacts to the change in one value of the course just once – i.e., when this value is received. This is why EMA is preferable.

Comments. As the charts given below indicate, MA crosses the price 11 times. However, where did E. Neiman see dogs who cannot “bark” more than once or twice? One can imagine how many traders have lost their deposits due to the recommendations given by E. Neiman .

The charts submitted below confirm my statements. Everybody can compare SMA with EMA in order to independently answer the following question. Is it preferable to apply rather EMA than SMA (as E. Neiman insists)? Or the difference between these indices is minimal? As one can see, analysts of Forex just play with exponential-, smoothed- and linear-weighted MA. In practice, various “improvements” in SMA do not heighten the working trader’s profits.

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Chart 14.7. EUR/USD pair movement on April 17-24, 2006(For view picture see notes in end of article)

Chart 14.8. EUR/USD pair movement on April 17-24, 2006(For view picture see notes in end of article)

Both J. Murphy and Hockhaimer were perfectly correct in pointing out the difference between SMA and EMA. At the same time, they have not drawn the principal conclusion that one can easily make issuing from the statistics submitted by these authors. That is both types of MA just slightly differ one from another. Besides, the same drawbacks are inherent in the both variants of MA.

· According to J. Murphy, deals must be opened after a slower MA is intersected by a faster one. However, in this case occurs a substantial (time) delay. This is depicted in the above-given charts (the intersection of MA ##10, 40). One can clearly see that MA intersection takes place when almost a half of the path is already passed through.

· According to J. Murphy, a deal must be opened not after the first intersection of MA ##10 and 40 but after the second one (the so-called “optimization”). However, I can give a large number of examples where the 1st intersection yields hundreds point of profit. At the same time, the 2nd intersection occurs in a flat (in its essence, it is attenuation of the previous basic movement). That is, J. Murphy does not recommend opening a deal during this basic intensive movement! Besides, as one can see in these charts, MA 12 times intersect one another. According to J. Murphy, which intersection is the 2nd one?

· How can J. Murphy recommend such “optimization” when it results in the following?

· Table 14.1

The kind of commodity assets

The best combination

The net accumulated profits or damages

The maximum sequence of damages

The total number of deals

The number of profitable deals

The number of deals made at a loss

GBP

3,49

117,482

-7,790

160

68

92

DM

4,40

78,631

-3,909

169

78

91

JPY

4,28

120,899

-4,367

131

74

57

SWISSI

6,50

172,454

-7,467

148

66

82

As one can see, J. Murphy’s results after his “optimization” are worse than 50/50. That is 322 deals of 608 are made at a loss.

· J. Murphy made an attempt to artificially combine MA with timing loops (time cycles). For this purpose, he made use of Fibonacci number “mysticism”. That is, he chose Fibonacci numbers according to his own tastes. Applying such numbers in some cases, under other conditions he “happily forgot” about them. In this sense, the case of MA ##10 and 40 is typical.

· J. Murphy has not elaborated a universal combination of MA. In each example different combinations of MA are submitted (either 10-40 or 1-21, or 13-34-144, or 4-9-18, etc.).

And what is more, according to J. Murphy, MA duration must be chosen so that it should correspond to the cycles that determine the given market development.

As a trader, I arrive at the distressing conclusions concerning J. Murphy technique of MA application at Forex – as J. Murphy gives examples of currency pairs.

· J. Murphy uses different combinations of MA at the daily trades. However, as a trader, he has not elaborated his own “working” combination of MA.

· Different MA can be required for different charts. J. Murphy clearly garbles historical examples of situations at the market, suitable for various combinations of MA.

· J Murphy himself considers that one can get a reliable prognosis with the help of his charts. The reader can develop his own opinion concerning this statement. Just I wonder, of what kind this “reliable prognosis” can be. Really, a universal technique of giving analysis to the market is not developed. In addition, in different situations different MA are used.

· However, J. Murphy never kept back that he was not a trader but a “technical analyst” and a Professor in New-York Financial Institute. In spring, 1981 the leadership of this institute ask him to organize a course of the technical analysis.

As far as I’m concerned, I made no secret of my attitude towards “analysts”. Really, to what the latter can teach a beginner or an experienced trader if such “analyst” cannot work at the stock exchange himself?

As it is evident, an author of detective stories (even the most gifted individual but not a lawyer) will never be invited to lecture in a department of law. At the same time, the analogous situation at Forex is almost a rule. For instance, training courses at Forex Brokers are mainly based on the books by J. Murphy and E. Neiman. I have already exposed mistakes, inaccuracies and drawbacks, inherent in just one chapter (#9) of the book “Technical analysis of future markets” by Murphy. As regards the whole book, the number of mistakes of various types is about several hundreds. All courses of training attached to various Forex Brokers contain those very mistakes. As the result, at least 19 of 20 traders lose their deposits.

However either E. Neiman or J. Murphy and other “analysts” don’t do this. Probably, E. Neiman, a leading employee of “UkrSocBank”, has no MA working combination of his own. Maybe, he just writes “financial bestsellers”. According to Alpina public house, in his books the basic notions and techniques, necessary for the successful trading, are submitted in the form easy of access. This is a point to be considered.

In brief, one can make the following conclusions.

· MA is an important parameter from the viewpoint of giving analysis to Forex market and gaining regular profits there.

· At present, the MA problem presentation technique by “classicists” of Forex has clearly appeared in deadlock. This is why the overwhelming majority of traders lose their money.

· I would like to emphasize the following. Either the numbers of MA, or their modifications (the simple-, exponential-, or linear weighted MA) do not matter. One must clearly distinguish when the work either along – or against MA reversal would be preferable. The reader must open a real account not earlier clearly understanding of the following factors. One must know when to work on the MA reversal and when against it. One must see with which other systems of analysis the technique of MA should be combined – in order to detect long and super-short deals. One must learn the signs of reversal and the trend continuation – as well as correlation between the trends themselves. You see, your chances to get into the company of 19 traders-losers from 20 are considerably prevail the opportunity of being 1 of 20 traders who regularly gains profit at Forex.

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