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TECHNICAL ANALYSIS

The Displaced Moving Average

Or Cutting Out the Noise in Intraday EURUSD Trading

Displaced-Moving-Averge1.png

The key to technical analysis is a cold, disciplined reading of the price data, the direction for sentiment that this highlights and the interpretation of that data into probable future movements and targets. This sounds easy but a key element is the purity of the data or, if that’s not possible (and it rarely is), a stripping away of the noise that surrounds price movement and the resulting effect it has on technical indicators. This is especially valid when it comes to intraday trading when each pip can have significant value.

By ‘noise’ I don’t mean the shouting of traders, brokers and salespeople that used to distract technical analysts throughout trading rooms but the noise created by volatile market movements - Stop losses triggered, event reactions, economic figure announcements and pronouncements by media analysts.

One of the simplest, and therefore best, methods of identifying trend is whether prices are trading above or below moving averages, even using a spot crossover of that moving average as a trigger for opening/closing of positions. It has been a signal that I have used for some considerable time but one that I’ve adapted to sidestep the ‘noise’ of the market generating too many false signals.
This adaptation is displacement.

First let’s quickly talk of the main types of moving average used:

Simple - a total of the relevant date is divided by the number of observations. Therefore each piece of data has the same percentage weighting.

Weighted - extra weighting is given to the most recent data. In the case of an 89 period moving average the last piece of data is multiplied by 89, the second last multiplied by 88 and the third last by 87, etc. The final figure is then divided by the total of the multipliers.   

Exponential - this is another, but complex, form of weighted average, with the difference being that every price is taken into account, with geometric progression, the older prices given less and less relevance.

Looking at the figure 1, 2 and 3 (EURUSD 2 Hourly charts) you can see that the downward trend in EURUSD  during this period is clear cut with lower highs and lower lows apparent.

Technical analysis Simple Moving Average EURUSD.png

Technical analysis Weighted Moving Average EURUSD.png

Technical Analysis Exponential Moving Average.png

While the initial bearish signal at the beginning of November was caught by the moving average cross, all moving average types are prone to bouts of painful whipping when minor rallies occur. The idea therefore is to eliminate, as much as is practical, false crossovers but normal filtering attempts either fail to make a positive difference or, in the case of the weighted moving average, increase their number. This is where the method of displacing the moving average helps to mitigate the noise that creates these false signals.

This is probably a good point to say that the moving average used in this 1st example is 89. There are many favoured moving averages, 20, 50, 100 & 200, being the most commonly employed but I have always believed  in the relevance of Fibonacci numbers and therefore my default is to look to 8,13,21,55,89 or as high as 144. The keenest optimisation is not to arrive at numbers that suit each asset but figures that can be continually used with consistent results without constant revision. This forms a method of practical application, as intraday trading is not a theoretical exercise.

Going back to the example above, let’s introduce the Displaced Moving Average. The chart on figure 4 is a return to the simple 89 period moving average as in figure 1 but this time pushed forward by 21 periods and you can immediately see the positive impact it has for trading - the spot price crossovers occur at later stages.

Displaced Moving Average 21 EURUSD.png

Although this means that when the moves are valid ones it has the disadvantage of the trigger being at a worse rate, this is more than offset by the reduction in false breaks. 

 

MOVING AVERAGE

Crossover

Simple

7

Weighted

15

Exponential

7

Displaced

3

If we set this out in a statistical format for this period and using, not a trade above or below, but a close through the average, we get the figures in the above table.  It is clear from this example how much more practical it is to use the Displaced Moving Average as a tool for intraday trading than it is for the other 3 types. While the examples above show 2 Hourly charts, this method of establishing trend but eliminating ‘noise’ can be applied to all time periods from monthly down to hourly charts and makes a significant difference to accuracy of recognising trends and trading them.

Finally, let’s look at EURUSD on the daily chart (figure 5). This time the period for the basic moving average (blue) is increased to 144 and, the displacement (magenta) applied to the 2nd line, 34. Obviously this is a tool for the longer term trader/investor but the displacement’s impact is clear to see.

Technical analysis 144 day Simple Moving Average EURUSD.png

Once again both moving averages capture the trend but the choppy price action during July and August 2011 detract from the effectiveness of the Simple moving average, while the Displaced was caught less often.

In conclusion I hope this article encourages a more active but flexible approach to the use of moving averages in identifying intraday/daily trends and using them to trade profitably.

Alan Collins