The 7 Pitfalls of Moving Averages

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Old Jan 8, 2016, 4:00pm   #1
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The 7 Pitfalls of Moving Averages

We've just published a new T2W article called "The 7 Pitfalls of Moving Averages " by Kalen Smith.

Quick Summary: Kalen Smith gives reasons why Moving Average indicators used when trading equities are often not an effective way of determining future price direction.

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Old Jan 12, 2016, 12:48am   #2
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1. Moving averages draw trends from past information. They don't take into account changes that may affect a security's future performance, such as new competitors, higher or lower demand for products in the industry and changes in the managerial structure of the company.

Doesn't historical data already have the news priced into it? Whatever news that happened during that time will have caused or not caused any changes in the market that results in the price that it ended up being, wouldn't it?

2. Ideally, a moving average will show a consistent change in the price of a security, over time. Unfortunately, moving averages don't work for all companies, especially for those in very volatile industries or those that are heavily influenced by current events. This is especially true for the oil industry and highly speculative industries, in general.

What is meant by a moving average will show a consistent change in price of a security, over time"? Securities do not change price at a consistent rate? If an exponential moving average is essentially and a derivative of a stochastic process mapping a security, then if the security changes price rapidly, so shall the EMA. Derivatives (calculus) map the rates of changes at a given in an underlying function or process. Using a discretized time step analysis, If a stock has a price of $50.00/share at t=0, $50.50 at t=1, $51.51 at t=2, then it does not have a consistent price change. The EMA or any other form, as it was not described which type of moving average was being used, wil reflect an acceleration in price. The derivative at t=1 = 1% and at t=2 = %2. I suppose I do not understand where the discrepancy and; thus, the problem lies with the part in red.

5. Many investors argue that technical analysis is a meaningless way to predict market behavior. They say the market has no memory and the past is not an indicator of the future. Moreover, there is substantial research to back this up. For example, Roy Nersesian conducted a study with five different strategies using moving averages. [color=]The success rate of each strategy varied between 37% and 66%. This research suggests that moving averages only yield results about half of the time, which could make using them a risky proposition for effectively timing the stock market.

If technical analysis has no value and the market has no memory, then what is the point of historical data? Why bother keeping historical data if it is irrelevant to the future? Many firms spend a great deal of money keeping and tryin maintain accurate historical data. Many services charge an arm and a leg for it. Does this mean that they are tantamount to snake oil salesmen? Additonally, wouldn't that make charting and the like obsolete as they rely upon historical data no matter how short of a time frame you look back?

I would be curious to know which strategies were applied specifically? What types of moving averages were used and which permutations? EMAs, WEMAs, SMAs? How long was the backtest period?
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