Due to the variety and complexity of things I
will need to talk about, I divided the article in 4 sections.
Whole article will show a study in GOLD, but of
course the very same setups are possible in all major currencies, after some
correction relatively to the currency behavior.
This first section will be dedicated to
understand what kind of MA to apply in a chart, to increase confidence in a
This m30 chart shows one of the most
representative situations we find in gold. I drawn some levels based in my
approach to a chart as I shown in previous articles
(weekly levels, pivots, PA, etc&hellip. I will never be tired to repeat that price
is the very 1st thing to look at.
According to the momentum, 1600 was (and is) a
demand area while 1700 was (and is) a supply area. I will show in next sections
reasons why we have main supply and demand areas and what to do to identify
When going from 1600 to 1700, price finds some
minor levels, causing reactions in points A-B-C-D. Nobody explain why we should
use a SMA instead (for example) of an EMA one, and also why we should use a 30
periods look-back instead (for example) of 200. So I found these differences by myself,
deeply studying the tool. I realized something very interesting.
It’s the very same chart with a very completely
different study, where I applied some of the most commonly used MA and another
Moving averages smooth price data, printing a
line that highlights the trend. However, the smoothing process introduces lag.
A short-term look-back period MA (blue) respond more quickly to price changes
but, due to volatility, can lead to whipsaw losses. Opposite scenario with a
long-term look-back period MA (red) due to the heavy numbers of changes it has
on it, will not react immediately at market, showing lag in reversal and
Quickly analyzing the chart I see as follow:
- A) End
of the week, price was below all three MA which usually means a downward move.
Green line is also downward. But I repeat: we are at the end of the week and in
demand area. Who is so crazy to open a short in GOLD in demand area at the end
of the week?!
- B) Price
opened week straight bullish going to a minor supply area and then showing weakness.
Blue and red lines crossed and reversed down, signaling possible more down,
while green line did not at all and still shows upward.
- C) Very
similar than previous point: price closing candle below daily opening price and
blue + red lines signaling down, while the green one totally not caring and
still showing upward.
- D) New
situation: price below blue and red lines again, and this time the green one is
flat showing a possible weakness.
What happened next?
Same situation with opposite direction. In
points E and F blue and red MA signaling upward while the green one not caring
at all and still showing (weak) downward and going very near to a good minor
We must identify which is the very best
representative MA for the pair we want to trade. Market changes behavior from a
week to another (sometimes in the middle of the week,) and also every pair has
In the charts above i applied blue (14EMA) and red
(60EMA): they are really no helpful, showing too many ‘false’ signals, while the
green MA is very good and always respecting what price is doing and also
following very well price when REALLY changes direction but, on the other side,
also showing flat in ranging market.
The green MA is the KAMA.
Moving Average” was presented in 1998 by
Perry J. Kaufman in his book “Trading
Systems and Methods, 3rd Edition”. Kaufman modified the
conventional Moving Average with the aid of an “adaptive” approach and the
intention to make it more trend-efficient. Simply a genius!
KAMA adapts to market volatility and trend by
switching to a shorter-term look-back period when the market is trending
up/down, and changing to a longer-term look-back period when the market begins
to move sideways.
The (K)AMA builds on the EMA calculation.
The formula is: KAMA = C * (closet – KAMA(t-1)) + KAMA(t.1) where “C” is the adaptive aspect of the
smoothing constant and there are a few steps involved in calculating it.
- First step is to calculate the efficiency
ratio (ER) (the ratio of price direction to price volatility):
- If price
close up 10bars in a row, the ER would be equal to 1, while in ranging market,
the ER would be equal to 0.
- Then calculation establish the
shortest (fast) and longest (slow) look-back periods that the KAMA will
reflect. The SSC (smooth smoothing
constant) formula is:
- The EMA smoothing constant calculation,
uses the formula 2/(n+1) to approximate the number of bars in a n-bar SMA.
Kaufman suggested the (K)AMA range from a 2-bar look-back period (fast) to a 30-bar look-back period (slow).
- Finally, Kaufman noted if market is
ranging the (K)AMA would still edge up and down just like an EMA. Squaring the
smoothing constant reduces this effect. So:
Applying the KAMA into a chart using JForex platform is very easy, since we already
find it in indicators.
As seen in the picture at point (1), I setup to
6 the fast MA periods value; also possible setup to 5. If need something faster/slower,
I switch on TF from m30 to m15/h1. At point 3 you could decide to make it
recalculate on new candle (better if you do). Point 2 is very subjective.
In this section I shown what is better do to
understand which kind of MA use in your trading, according to what you need to
read and according to the pair you want to trade.
My trading in GOLD (like every pair) will then
require something more than a line in chart, as I will show in next articles.
Meanwhile, I hope this will be an easy way for beginners to use a bit more
complex tool, but in the same time, something very helpful for trading.
My advice: use ONLY and ALWAYS one MA in your chart.
Good luck in your trading.