Traders and investors often want to know where the money is flowing for a specific stock or index, with the aim of trading with the trend. So today we’ll be looking a some simple way to spot the direction of these money flows, in the short and long term.
Moving Average Crossovers
In their simplest forms moving average crossovers are used to identify potential trend changes, as seen in this recent chart of ANZ:
ANZ CHART #1: Recent Chart of ANZ with the 20 and 50 day moving average crossover.
Multiple Moving Averages (MMAs)
The simple moving average crossover lacks a vital piece of the puzzle, that is – where is the weight of money flowing. This is where the MMAs – Multiple Moving Averages come into play.
Daryl Guppy has developed a system that can be incorporated into IRESS_Trader software. This MMA system uses multiple moving averages to identify how the short term and long-term investors are positioned in the market, and has written a book on the topic “Guppy Trading”.
Two groups of investors are categorised as the long-term investors: those that have to allocate money to the markets, like fund managers, hedge funds and the like, who are in the market for the long haul (months to years); and the short-term traders who have a shorter term focus from days to weeks.
The two groups of investors are represented on the chart by a series of moving averages. The long-term investors are illustrated in red and are shown by drawing the 30, 35, 40, 45, 50 and 60 day exponential moving averages. The short-term traders are illustrated in blue and are shown by drawing the 3, 5 7, 10, 12 and 15 day exponential moving averages.
The major premise of this system is that markets go from periods of inactivity, where prices contract as volatility decreases and where the two groups struggle to agree on what the “real value” of the stock should be. The share price then expands as one or other of the groups starts to dominate and places their money behind their conviction.
Key elements of the MMA system
• COMPRESSION – where the MMAs converge as the two groups agree on value and price (always temporary and is followed by price expansion) (refer to ANZ CHART #4).
• SEPARATION – is the spacing between the MMAs. Ideally you want wide separation in the long-term group as this confirms the trend (refer to ANZ CHART #3).
• BALANCE – when the short-term group penetrates the long-term group the trend is over (refer to ANZ CHART #4)
How to Anaylse the MMAs
• Identify the degree of compression and separation in the short-term MMAs
• Identify the degree of compression and separation in the long-term MMAs
• Identify the degree of separation (spacing) between the short and long term groups
How to Trade Using MMAs
• Points of temporary stability and agreement imply high probability of inherent instability in the near-term. As a general rule the longer the agreement on price, the more powerful the impending move.
• Major turning points and changes in trend occur when both groups converge and crossover almost simultaneously (eg. Mid-December for ANZ, see ANZ CHART #4).
• End of trend occurs when the short-term group penetrates the long-term group. The power of the move is greater the longer the consolidation period is (eg. Mid-November for ANZ, see ANZ CHART #4).
• When both the traders and the investor group MMAs contract and converge, prepare for a dramatic increase in volatility and price expansion.
• Trade in the direction of the long-term MMAs, which confirm the “weight of money” and ultimate direction of price.
• Trade in the direction of the crossover.
• Once the long-term MMAs are engaged (that is you see separation (spacing) between the long-term MMAs) use the contractions in the short-term MMA for setups to enter on pullback.
Example 1 – ANZ Bank (ANZ)
The banks have had a powerful move since last November and you could have used this MMA system to trade ANZ stock and to remain in the trade because you were comfortable with where the weight of money was flowing.
Analysing ANZ from the view of the short-term traders, we see that the short-term MMAs engaged exhibiting separation in mid-January.
ANZ CHART #2: Short-term traders in ANZ
Analysing ANZ from the view of the long-term traders, we see that the long-term MMAs have supported this up-move in ANZ from mid-December when there was a crossover in the short and long term MMAs. The MMAs went on to exhibit separation in early February, indicating strong support from the long-term investors for this up-move.
ANZ CHART #3: Short-term traders and long-term investors in ANZ
The bigger picture for ANZ:
ANZ CHART #4: Short-term traders and long-term investors in ANZ (12 month view)
We have seen some weakness in ANZ in recent days with the price (the green line) penetrating the short-term trader’s MMAs for the first time since last November. Investors looking to accumulate on a pullback would be looking at the long-term MMAs for guidance for support levels (around the $28.00 and $27.00 levels in this case).
Example 2 – Fortescue Metals (FMG)
The trend in the resource stocks has been less well defined in the past six months, as illustrated by the Fortescue chart below:
FMG CHART #1: Chart of Fortescue (FMG)
However the MMA system can be used quite profitably as turning points are indicated on the chart. In mid-October we saw the short-term and long-term MMA groups crossover, indicating a change in trend. The subsequent pullback and MMA contraction in December was the ideal setup for a powerful move higher. Mid-January gave an ideal opportunity to top-up, as the short-term MMAs contracted as the long-tem investors were fully engaged. Mid-February we saw the trend change as the short-term MMAs and price (the green line) penetrated the long-term MMAs.
FMG CHART #2: MMA System for Fortescue (FMG)
The MMA system is ideal for trending stocks and keeps you trading in the direction of the “big money”, as shown in the ANZ example. However it also provides some great signals when the trend is less well defined, as shown in the Fortescue example.
Whether you are a short-tem trader or a long-term investor always trade in the direction of the long-term MMAs. If there is contraction in the MMA groups look for a crossover to confirm a change in trend. The real money is made by trading in stocks where you see separation (spacing) in the long-term MMAs.
The MMA system is a valuable addition to everyone’s trading tool kit and can be incorporated into IRESS_Trader software.
The market volatility has been at unprecedented lows since bouncing from the November lows. There is another trade setting up right now, that you could potentially profit from. If you would like more information please contact me at 1300 610 024 or email email@example.com.
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Investment Adviser – D2MX Trading
This report was prepared by Michael Hevern. It represents the views and opinions of the author. It is not intended for use by any third party, without the approval of Michael Hevern. While this report is based on information from sources which are considered reliable, its accuracy and completeness cannot be guaranteed. Any opinions expressed reflect my judgment at this date and are subject to change. Contracting Hevern Pty Ltd is a Corporate Authorised Representative No. 408868 of D2MX Pty Limited ABN 98 113 959 596, AFSL No. 297950 (D2MX), and Michael Hevern has been appointed as an Authorised Representative of Contracting Hevern Pty Ltd. Opinions, conclusions and other information expressed in this report are not given or endorsed by D2MX, unless otherwise indicated. The information contained in this Report is General Advice only, as the information or advice given does not take into account your particular objectives, financial situation or needs.
Disclaimer: Using leverage to invest can be a two edged sword, as it can magnify your returns when the stock price rises, but will in turn magnify the losses if the trade does not perform as expected.