The direction of longer moving averages: A simple technical tool

In Trading strategies, Moving averages are without a doubt the most popular trading tools. Moving averages are great if you know how to use them but most traders, however, make some fatal mistakes when it comes to trading with moving averages. Sometimes very simple technical tools can be very helpful when you are trading, especially when you have a clear idea of the underlying macro picture.

Large moves in most markets are generally underpinned by a key macro story revolving around the path of interest rates and where a country is at in its economic cycle. So, lets say that you are convinced of a major narrative, but are unsure of which technical tool to use. The answer can be surprisingly simple.

The direction of the moving average

Although Moving averages themselves are some of the oldest tools used in technical analysis. It is constructed by taking the average price over a specific number of periods. The moving average is a simple average of the last prices in a sequence. A 10-day moving average is the average of the last 10 days of trading and a 20-day moving average is the average of the last 20 days of trading. The average is constantly updated when the last day of the sequence drops off and a new day of price is printed. So, all straightforward enough.

One very simple technique is to trade in the direction of the moving average. But take note that, just because it is simple it does not mean it is ineffective. When it points up, go long and when it changes direction exit the trade. Below you can see the approach that could have been taken when the Federal Reserve announced significant support packages to help the US economy through COVID. Would that support US stocks as interest rates plunged and support grew？ Yes. How could you have benefitted from that move and managed the trade？ Simply by using the direction of the longer-term moving average. So, one interesting way to trade major indices on huge macro moves is just the underlying direction of the moving average.