|Support & Resistance|
Using two moving averages - one of shorter length and one of longer length - to generate trading signals is commonly used among traders today. This method, known as the "double crossover method," is especially suited for securities that happen to be in trending, as opposed to range-bound markets. (Trending markets are characterized by steady upward price movement in bull markets and steady downward price movement in bear markets. Prolonged sideways movement with little sustained progress up or down is characteristic of "range bound" markets.)
There are many different ways in which this double crossover method may be used. The combination possibilities are endless. The two moving averages can be daily or weekly, but one must always be of a shorter time frame than the other. For example, you might consider using a 12- and 24- day moving average in conjunction with security's price chart. Or a 10- and 30- day, or a 30-day and 60-day average. The shorter moving average measures the short-term trend, while the longer MA measures the longer-term trend. Buying and selling signals are given whenever the two cross over or under one another.
Trading rules for the double crossover method are quite simple: whenever the shorter-term moving average crosses above the longer-term moving average - and the longer-term MA happens to be rising - a buy signal is generated. Conversely, whenever the shorter-term average falls beneath the longer-term average - and the longer-term average happens to be falling - a sell signal is generated.
BigCharts.com provides a free charting service through its internet site (www.bigcharts.com), which contains charting tools for constructing several varieties of moving averages. The daily and weekly bar charts on the BigCharts.com Web site can be modified to the time frame that best suites the trader. Included in this chapter are a number of BigCharts.com stock charts, and the buy or sell signals they generated based on the crossover method using the 30-day 60-day moving average. Bear in mind that the same rules that apply for interpreting the 30-day and 60-day moving average combo apply for all types of double series moving averages; and can be used for all time frames, including daily, weekly and monthly charts.
Here is a fine example of how the double crossover system of moving averages works in J.P. Morgan. Here, the daily chart provides a buy signal when the shorter 30-day moving average crosses over the longer 60-day moving average. Conversely, a sell signal is flashed when the longer of the two averages (60-day) crosses over and remains on top of the shorter average (30-day). This basic rule of thumb applies for moving averages of any size and not just the 30-day and 60-day functions. Notice in March 1999 that the first buy signal was given as the 30-day average (light colored line) crossed on top of the darker 60-day line. So long as the price bars were rising and remained on top of the averages, the buy signal remained intact. This was the case from March through June 1999, at which point the priceline dropped underneath the averages and the averages started turning down, indicating a loss of momentum. In August 1999 the 60-day average crossed on top of the 30-day average, flashing a sell signal. This continued until November, when another buy signal occurred. However, since the two moving averages got so far out of synch with one another, it warned the trader to avoid making a commitment to the stock until the averages got back in line. The next "in-line" buy signal occurred In August 2000 (note how the two averages interacted at this time on the chart). Because the two averages became widely spaced apart shortly after this signal, it indicated that an over-bought condition was developing in J.P. Morgan. Therefore, the prudent trader would have been right to look for exit signals. The first such signal came in October, at which time the 30-day average turned down and failed to support the priceline. Even though a crossover did not occur until one month later, it would have been wise to sell out when the first 30-day moving average turned down. The rules for interpreting single line moving averages still apply when interpreting double line moving averages, even when the two lines have not crossed over yet.
A buy signal in the Standard &Poor's Depository Receipts (SPY) remained in place throughout 1999 until August of that year until the two moving averages started rounding off and turning down. Shortly thereafter, a bearish crossover occurred, though it would have been wise to exit long positions as soon as the moving averages - particularly the 30-day average - starting curving over, reflecting waning momentum. Another strong buy signal was given in November 1999, when the 30-day average crossed the 60-day average. It soon starting curving over, however, and the priceline began a prolonged sideways movement into the year 2000. The next formal sell signal was flashed in September, at which time the 60-day average crossed over the 30-day average. The sell signal remained in place through the remainder of the year.
General Motors provides a clear sell signal in its daily chart In May 1999 (note crossover and downward curve of moving averages and their relation to the priceline). A buy signal was given in October 1999 (note bowl-shaped bottoming pattern of moving averages, the rising priceline in relation to the rising averages and the crossover of the shorter average (30-day) on top of the longer average (60-day). The next sign of trouble came in May 2000, when the two averages got out of line with both curving over. The priceline plunged through both of them before bouncing higher. This should have been the trader's signal to exit all long positions in GM and sell the stock short. Remember, when trading using two moving averages, you do not necessarily have to await a crossover before making a trading commitment - a simple curve of one or both of the moving averages, or a failure of the moving averages to contain the priceline is all the signal that is required. The crossover serves more or less as a confirmation to the preliminary buy or sell signal.
Here is a daily chart of DuPont (DD), a leading industrial stock and a component of the Dow Jones Industrial Average. A strong buy signal was given in April 1999, when both moving averages were close together and moved up at the same time while the price bar were also rising. A separation of the two averages occurred between May and June of that year, followed by a curving over of the shorter (30-day) moving average in June. This provided a preliminary sell signal to the alert trader. An all-out sell signal was given in September when the 30-day average fell below the falling 60-day average. This was followed by falling prices and then a short-term buy signal in December 1999. However notice that in the month between December 1999 and January 2000, even as DuPont's priceline was moving higher, the 30-day moving average ascended while the 60-day average never followed suit. Instead, the 60-day moving average, after a short rise in December, quickly turned back down and continued to curve lower even as the 30-day average was rising. This is what is known as divergence, and it is typically bearish. In cases like these where one moving average gives a buy signal while the other give a sell signal, it is best to exit long positions and either await a clearer signal before re-establishing trading positions or else sell short (if you are an aggressive trader). The longer of the two averages holds more significance, so in this case the fact that the 60-day average was falling implied that the longer-term trend was still down; therefore, short positions were justified. The sell-off continued throughout the year 2000; however, notice how the two averages had moved close together and were starting to round off in bowl fashion. This provides a clue that the sell-off likely has halted and that accumulation could be underway. The trader should watch this chart carefully in anticipation of the next buy signal.
A bullish buy signal continued throughout 1999 and into the early part of 2000. Notice, however, that the moving averages began moving apart in early 2000 and continued to spread apart into April, at which time the 30-day moving average started to curve over with the 60-day average soon following suit. The first sell signal was given in April when the priceline for Cisco Systems fell through both averages. Although there was quick bounce back, the curvature of the averages plus the fact that the priceline had previously plunged through them, was strong evidence that Cisco's bull market had ended and that further weakness could be expected.
The chart provided on the next page for Chinadotcom Corp (CHINA) is a great example of how a moving average system can serve to protect traders from adverse moves in the stock market. After an extraordinary advance from its initial public offering in July 1999, CHINA proceeded to rise to a price of nearly $80 a share in March 2000. The large gap between the priceline and the moving averages that occurred in March 2000 (just before the crash) was a preliminary warning that the stock was due a significant pullback. Although there is no hard-and-fast rule as to just how far the distance between the priceline and moving average should be before a sell signal is given, it is up to the trader to use discretion based on the "average" distance between the two over the long-term. Whenever it becomes plainly evident that there is a wide separation between the moving average and the priceline, the trader should prepare to either sell or sell short. Notice also how both averages - particularly the 60-day average - began losing momentum and curving over just before the sell-off occurred. This was yet another advance warning that a plunge was imminent. After the initial crash, CHINA continued to trade below the two moving averages for the rest of the year, indicating that selling pressure was intense throughout.
The chart for Boston Properties (BXP) served as a wonderful guide for making profits over a two-year period. Using the double moving average system, a trader, after initially buying in April 1999, knew to sell short between May and June of that year as the gap between the 30-day and the 60-day moving averages widened conspicuously. The sell signal was confirmed in July as the averages crossed over. The trend remained down until December 1999, at which time a preliminary buy signal was flashed as the two averages bottomed and turned up together (the crossover occurred the next month). After a rocky start in the initial months of 200, a firm buy signal was flashed in March, and from there prices headed higher. A preliminary sell signal was given in September 2000, as both averages lost momentum and curved over. Although the next firm buy signal had not been given as of December, it was beginning to look like a distinct possibility. Note how both averages are very close together and appear to be turning up with the priceline moving higher. However, as a clear-cut buy signal has not yet been flashed it is safest to remain on the sidelines awaiting a clear signal. Both averages must turn higher before a long position can be safely established.
Resource Asset Investment Trust (RAS) is a dynamic stock that can be traded with wonderful results using a double moving average trading system. Note here the interplay between its 30-day and 60-day moving averages. Note especially how the two lines cross through each other at critical turning points along the timeline. Whenever the 30-day moving averages crosses through and above the rising 60-day average, it always precedes a big run-up in share price. Note also how well the averages tend to act as support and resistance for the priceline. The first significant buy signal came in May 1999 when the 30-day MA crossed through and above the 60-day MA. Both curved over in August, at which point the trader should have sold short. A "rounding" process occurred between November 1999 and July 2000 during which time both the priceline and the averages produced a bowl-shaped curve, implying accumulation was taking place. The next buy signal was finally flashed in July 2000, which saw RAS rocket from its low near $10.50 to a high of nearly $13 in three months - a hefty percentage gain. After a prompt sell-off from the October high, the averages curved over and failed to support the falling priceline, at which time the trader should have sold. By December, however, the 30-day moving average appeared to be ready to cross through the 60-day average, which would send another buy signal.