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MOVING AVERAGE VARIABLES, Forex
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If trades are based on the market-direction number or the three-period pivot point moving average, there is no need to wait for the value of the

moving average to start rising or falling to determine the trigger to enter the market. A close above the moving average will trigger a long position, and a close below the moving average will trigger a short position. However, we want to see the moving-average values follow the direction of the price move in the desired trade.

The conditional moving-average system incorporates the pivot point moving-average approach with another variable. This method combines two moving averages. The resulting system provides a powerful cross over trigger to enter the market as well as an indicator of the move's strength with the slope and the difference (or separation) of the moving average lines.

A crossover provides both the entry and the exit signals, in addition to a set of rules or conditions. This system works on any time frame, five min utes and greater, in any high-volume market. It is an excellent short-term trading method for highly liquid markets such as forex, certain futures markets, and stocks that have ample trading volume.

There are other variations one can use, such as a five-period pivot point moving average with a two-period simple moving average of a close. I test various time periods and variables for my parameter settings be cause of the various trading conditions each market has. After all, bonds move differently than the Standard & Poor's index (S&P), or you may agree that forex currencies move differently than individual stocks. The bottom line is this: I use the two moving-average values to help me identify a shift in the market's momentum; and then as the conditions change, such as a close above or below the values of both moving averages, I use the pivot point filtering method to help me identify a potential profit target. Experiment with the individual pairs or cross currencies using different time varibles in your moving averages to see if one set of values “hugs,” or traces better than, another.

For the purposes of this book, let me show you how to integrate the pivot point with the three-period moving average of the pivot point. In the previous section, I disclosed how to filter the pivot support and resistance levels by labeling the market condition as neutral, bullish, or bearish. We can also chart and track the conditional change of the market by plotting the directional change in the two moving-average settings.

Figure 2.23 shows both moving-average values declining; but as the pivot point crosses above the three-period moving averages, it alerts us that the internal market condition is changing to bullish.

Once both moving averages start to point up and the pivot point is above the three-period pivot point average, the market conditions con firm that we are in a bullish trend. As a general rule, a trader would look to buy from an area of support in a market that is trending upward (buy pullbacks)

Note that prices traded above both moving average values and that the three-period pivot point moving average acted as support all the way up. The moving averages were moving in tandem with each other, and the slope of both averages was pointing in the direction of the trend.

This is an important point, so let me reiterate: What helps indicate the strength of a trend is using two or more sets of values for the moving averages and also these:

• The slope of both moving averages is pointing in the direction of the trend.

• The moving averages have a good degree of separation or are equidis tant from each other, which indicates a steady trending condition.

• The moving averages are trending in tandem or are parallel with each other, rather than one outpacing the other.

• If the shorter-term moving average separates or moves too far away from the longer-term moving average, then you have a potential for an overbought condition, and you should start looking to liquidate half of your positions.

• When a crossover occurs, liquidate the entire position.

In Figure 2.24, let's go over what I have called my specialized condi tional optimized moving average system (the COMAS™ method) using the one-period pivot point with the three-period pivot point moving average on a 15-minute chart for the spot forex British pound versus the dollar. The first noticeable benefit of a short-term time frame for the moving average

values is that they become more sensitive to price changes and can give a trader an earlier warning of an impending market reversal. You can see that at the top the crossover of the two moving averages occurs in line with the hanging man candle pattern. Notice how, as the market descends in a free fall, a hammer candle forms as the moving average values cross one more time, indicating a potential directional price change. The confirmation of a reversal exists as a conditional change occurs as developed by a higher closing high; prices are now closing above the open (white) candles, and we have higher highs and higher lows and the market close above both moving-average values. It is at this time that you can place a buy order at the candle's close after the hammer forms or the next period's open; place your stop below the lowest low of this series of lows.

This feature of using two pivot point moving averages allows you to have an early warning system in place to help spot conditional price changes. Figure 2.25 shows a daily chart with the spot forex British pound. As you can see, the moving average crossover that occurs on July 19, 2006 , foretells the bullish trend reversal that carries the market from the 1.8420 level all the way up to the 1.8600 area. In that trend run, you will see how the moving averages both lined up and acted as support. The market made a short-term peak and corrected for two days before resuming its massive rally. The candle chart formed an equal and opposite pattern (which forms very frequently in the forex market). Notice how the moving average

crosses back down, giving you an early warning that the trend was in jeopardy. Then, sure enough, they crossed back up again, indicating the bullish trend might resume. In that trend run that occurred, the one- and three-pe riod pivot point moving averages related quite closely with prices, indicat ing a support level all the way up to the peak on August 8 at 1.9144. Combining the candles with the pivot point moving averages is paramount in helping to stay long in a strong-trending market condition. I want you to study the sequence of events in respect to the candlestick charts: They have higher highs and higher lows, and the closes are above the opens. Prices close above past periods' or the prior time period's highs. Keep that in mind when you are trading. We are going to go over candle patterns in the com ing section, and I will be reviewing these patterns in depth.

As illustrated in Figure 2.25, the COMAS™ method works in helping to determine changes in market conditions from a bearish downtrend phase to a bullish uptrend phase. Figure 2.26 illustrates a bearish conditional change in the market once the pivot point crosses beneath the three-period moving average pivot point. Once you have identified that a bearish condi tion exists, then you can trigger a short position. As a general rule, a trader would look to sell from an area of predetermined pivot point resistance lev els, especially in a market that is in a longer-term downtrend. In other words, sell rallies in bear markets.

In trading, as in life, timing is everything. There is nothing more frus trating to a trader than to correctly analyze the market, correctly predict the direction of the trend, get stopped out due to a premature entry, and watch the market launch in the predicted direction. As we all determine early in our trading careers, being correct about the direction of the trend is not enough. We must also be able to anticipate when the market is setting up to trigger an appropriate entry into the market. The pivot point com bined with a moving average of the pivot point is one method worth utiliz ing in your trading approach; it can help you successfully identify when a conditional change may occur in the market.

Let's look at Figure 2.27, which is a 15-minute chart on the spot forex cross euro currency versus the Canadian dollar. Notice the three-period consolidation after the long white candle prices went in a sideways mode or consolidation phase. It is this period that pulls off the sidelines traders who are expecting a continuation of the trend and get long at the top. How ever, the pivot point moving averages made a negative cross, indicating a downward reversal. The crossover occurs followed by a low close doji sell signal, followed by a sequence of events with lower closing lows, lower highs, lower lows, and closes that are below the opens, as the dark candle represents. In addition, the sell signal was generated when the price closed beneath both moving-average values. As the market collapsed, you can see how the moving averages acted as resistance all the way down, until the market moved into a consolidation phase.

The concept of incorporating pivot point analysis with a moving

average approach will give you a testable, mechanical, systematic approach to trading. In order to execute a trade, you need specific elements to occur. Knowledge of these elements will arm you with critical information that can help to prevent you from overtrading, as well as helping you avoid mar ket and emotional pitfalls. For starters, in order to execute a trade, you need to see a change in market direction and commitment from the market to illustrate a change in market direction by closing above or below the moving averages. Next, you need to follow some simple rules, such as taking buy signals at support and taking sell signals at resistance. The im portance of this trading method is that you must be able to apply the tech niques on a consistent basis; this will allow you to make decisions in a mechanical and nonemotional way. A common mistake that traders make is that they do not test a strategy and make a logical determination if the strategy is viable for their trading style. Many traders adopt a new strategy, trade with it immediately, and start tweaking different components of the strategy. Then they decide that there is no merit to the strategy because they are not making a profit, and so they begin looking for a different strat egy. A much better approach is to establish a defined set of trading rules and test those rules until a positive outcome is determined based on a rea sonable number of trades. In order for you to be successful as a trader, you cannot anticipate an outcome; you must develop the patience to wait for

your triggers, and you must also develop the discipline to follow through with that trigger. These character traits can be learned and developed by implementing this methodology. It is what I teach students and other highly successful professional traders. When the price target has been met and the trigger has presented itself, enter the trade without hesitation. Do not think about the entry; this should be a mechanical process. You have already done your homework, and you have satisfied your criteria. Your system is in place, and this is part of the system. If you do not place the trade when the trigger executes and confirms, you are not trading according to your plan. Successful traders have the courage to act and to act promptly. It is important to recognize the immediate environment or market condition. Is it up, down, or sideways? Let's say a bullish trend is established. It should consist of higher highs and higher lows; each period should close above the open, and we should see higher closing highs. The pivot point moving av erage should help verify this condition. In a bearish trend, we would want to see lower highs and lower lows; each period should close below the open, and we should see lower closing lows. Under these circumstances, the pivot point moving average should confirm this market condition as well. First and foremost, investors need to identify whether they are day, swing, or position traders; this will help them follow what time frame to fol low a trending market and when to exit a trade or what to expect from a trade. Are you day trader? Are you a swing trader. who may be in a position that lasts two to five days? Or are you a position trader? Once you ac knowledge what your time objective is, you can narrow down your goals and expectations for the trade. For example, when I am day trading, I will generally be able to identify what the average range for a day is and expect that if I miss 20 percent of the bottom and 20 percent of the top while waiting for a moving-average crossover signal, then I can expect to only capture 60 percent of the average daily range. Table 2.1 shows the breakdown of the prior 10 sessions' ranges. It can be determined, on average, to expect at least a 98.6-PIP (percentage in points) range in the next few sessions with the highest range at 143 PIPs and the smallest at 46 PIPs.

If you can expect to capture at least 60 percent of the recent time pe riod's average daily range, as this example shows, it would be 59 PIPs. So you can set your profit target goals based on recent historic price action for a realistic profit objective, or you can use the pivot point target levels as a guide. Figure 2.28 shows a 60-minute chart on the euro currency with the buy and the sell arrows with the predicted pivot point support and resis tance levels. If you take the buy signals at support and take the sell signals at resistance, you can filter out better trades and allow yourself to have predetermined profit objectives based on historic data as well as on pivot point targets

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