Moving averages, when used on their own, are best used as indicators for assisting your chart analyses in the ways described in the previous post rather than as trading systems in their own right.
When trying to create a real money trading system generally you are better to use the moving average as an important component part of your trading system rather than it comprising the entire trading system.
This advice would apply to pretty well all indicators. Indicators in their raw state do just what the name implies they give just a general “indication” whereas a trading system needs to be a more complete solution – so indicators are not trading systems and cannot really be used as such – they more generally form parts of systems.
Probably one of the simplest and most consistently profitable commodity trading systems over the last 15 years or so, that I have come across, does just that. It starts with a simple moving average but then builds that into Bollinger Bands and then adds trailing stops to create a complete system.
YouTube no doubt has hundreds of videos on these for those that want to understand the calculations and underlying concepts behind Bollinger Bands a bit more. Suffice it to say for the purposes of this blog that Bollinger Bands take a moving average and then plot a band above and below that moving average. Typically the band width may be set at 2 standard deviations. This means that 95% of the time price would be expected to remain within the confines of those outer bands.
So a typical longer term trading system trading daily charts may take say a 70 period moving average and then plot bands say 2 standard deviations above and 2 standard deviations below this level.
So how do you trade this ? well contrary to “common sense” the most effective way is to buy the breakouts above the upper band and sell the breakouts below the lower band as illustrated with the arrows below.
The dotted line is the moving average with a buy band plotted above and a sell band plotted below.
Such a trading system is known as a reversal system because it is always in the market ie it is either always long or short the market.
Amazingly this simple method has produced one of the most consistently profitable end of day commodity trading systems in the world. It trades across a whole basket of Commodities.
As you can see from the above chart it is also not too shabby when applied to currency markets.
This type of trading system is designed to allow the trader to get in on any big trending moves that develop. It works superbly in the sorts of trending markets such as we have seen recently in the US$ and Oil etc and will often keep you in the trade all the way up or down on what can sometimes be some gigantic moves.
There are a few more bells and whistles that can be added to further improve performance and reduce draw downs using, for instance, profit targets and additional trailing stops. But even using these basic rules you have a simple workable trading system based on moving averages that will work.