A relatively strong moving average combination for day trading

Day traders need continuous feedback on short-term price action to make lightning-quick buy and sell decisions. Intraday bars wrapped in multiple moving averages serve this purpose, enabling quick analysis that highlights current risks (as well as the most beneficial entries and exits). These averages also act as macro filters, telling the observant trader the best times to stand aside and wait for more favorable conditions.

Choosing the right moving averages adds reliability to all technical-based day trading strategies, while poor or incorrect settings undermine otherwise profitable approaches. In most cases, identical settings will work in all short-term timeframes, allowing the trader to make the necessary adjustments through the chart’s length alone.

Given this uniformity, an identical set of moving averages will work for scalping techniques, as well as for buying in the morning and selling in the afternoon. The trader reacts to different holding periods using chart length alone, with scalpers focusing on one-minute charts, while traditional day traders examine five-minute and 15-minute charts. This process even extends to overnights, allowing swing traders to use those averages on a 60-minute chart.

5-8-13 Moving averages

The combination of five, eight and 13-bar simple moving averages (SMAs) provides a relatively strong fit for day trading strategies. These are Fibonacci set settings that have stood the test of time, but interpretive skills are required to use the settings appropriately. It is a visual process that examines relative relationships between moving averages and price, as well as moving average slopes that reflect subtle shifts in short-term momentum.

Increases in perceived momentum provide buying opportunities for day traders, while decreases in momentum can indicate timely exits. Declines that cause bearish moving average crossovers in various time frames present short selling opportunities, with profitable sales covered when moving averages start to turn higher. The process also identifies sideways markets, which tell the day trader to stand aside when intraday trends are weak and profitable opportunities are limited.

Examples of using moving averages

Invesco QQ Trust (QQQ), indicated a trend reversal using the 5-8-13 bar SMAs, as illustrated in (A) in the line chart above. Later in the trading session, around lunchtime, there was a test of the uptrend as seen in (B). The test did not result in a reversal and the ETF continued to rise into the mid-afternoon trading session.

At (C), the 5-8-13 bar SMAs indicated a break in trend. This lasted until the end of the trading session. At the new trading session, (D), the uptrend resumed until another break occurred at (E) during the lunch hour.

The first leg of the uptrend, (A) to (C), lasted 51.5 minute bars and returned 2.59 points or 0.79%, without adding spreads and commissions. The second leg of the uptrend, (D) to (E), lasted 35 bars and created 2.64 points or 0.8%, without adding spreads and commissions.

Signals to stand aside

Interrelationships between price and moving averages also indicate periods of unfavorable opportunity costs when speculative capital should be conserved. Trendless markets and periods of high volatility will force five-, eight- and 13-bar SMAs into large-scale sweeps, with horizontal orientation and frequent crossovers telling observant traders to sit on their hands.

Trading ranges expand in volatile markets and contract in trendless markets. In both cases, moving averages will exhibit similar characteristics that recommend caution with day trading positions. These defensive traits should be committed to memory and used as a dominant filter for short-term strategies because they have a major impact on the profit and loss statement.

At (C), QQQ bobs and weaves through an afternoon session in a choppy and volatile pattern, with price whipping back and forth in an approximate one-point range. The respective SMAs show similar sweeps, with multiple crossovers but little alignment between moving averages. These high noise levels alert the observant day trader to pull up plays and move on to another security.

The Bottom Line

There is no perfect set of moving averages. The 5, 8 and 13 bar simple moving averages provide relatively strong input for day traders looking for an edge in trading the market from both the long and short sides. This technique also works well as filters, telling quick market players when the risk is too high for intraday entries. Nevertheless, individuals looking for alpha should also consider other simple moving average parameters and even other technical analysis indicators.