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In This Issue:
FInd out how an experienced trader uses Adaptive Moving Averages to determine market trends.

March 23, 2007
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Silver! Trade 10
Commission-Free
Contract Sides



- Don’t Trade Futures
Without a Plan!



- Free Podcasts and
RSS feeds from
Lind-Waldock




- Free Lind eWire
Newsletter. Information
and Strategies for
Traders of All Levels



- LME Metals are Hot! Aluminum, Zinc,
Nickel, etc.

 

 

 

 

 

 

 

 

 

 

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Spotting Market Trends and Trades with the Adaptive Moving Average

If you use technical analysis in your trading approach, you are probably familiar with simple moving averages. I like to go a step further and use what I feel is an even better tool to help me determine trends, and where to enter trades—the adaptive moving average. I’ll apply this tool to recent activity in the gold, crude oil, copper, corn and S&P 500 futures markets to see where I think the markets may be headed next.

I like to use candlestick charts, which you’ll see displayed in my market examples. Candlestick charts provide a quick visual picture of the relationship between opening and closing prices and their relative strengths or weaknesses, especially for extended periods. The body, which looks like a candle, represents the difference between opening and closing prices. Shadows, which look like wicks, represent price action above and below the body.

(continued below...)


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On my charts, the blue line represents the adaptive moving average, while the black line on the bottom is a derivative of the adaptive moving average, the rate of change oscillator. I look to trade in the direction of this oscillator, which measures the speed of the adaptive moving average. When it’s pointing up, I would want to get long, and when it’s pointing down, I would want to get short.

While a simple moving average is calculated by adding the prices for a predetermined number of days (or other time periods) and then dividing by the number of days (or other time periods), the adaptive moving average is more complex, and I feel, more sensitive. I won’t get into the nuances of the formula for determining the adaptive moving average, as it’s rather complicated and most charting software can display it for you. It’s not really important to churn through the formula yourself, it’s more important to know how it’s used. Keep in mind, you want to use the adaptive moving average in conjunction with your other technical analysis tools to help you determine the strength of a trend, and where to enter and exit trades. With any tool, you don’t want to rely on it exclusively. Don’t just see a signal, take a position, and walk away. Always use proper risk-management techniques, and always monitor the markets. If you don’t have the time to do so, use the assistance of a professional broker like myself. Market conditions can quickly change and you have to be nimble when trading futures.

Gold

First, let’s look at recent activity in the gold market and how I use the adaptive moving average to determine a trading strategy for my clients. The chart of COMEX April gold futures up to March 20, 2007, shows the market had been in a $20 trading range from $640 to $660 an ounce for roughly two weeks in early to mid-March. Given this range trading environment, we can see how the adaptive moving average has likewise moved sideways and has not offered much of a signal to enter a trade. April gold did climb above $660 on March 20-21, and I would like to see closes in April gold above $660 to confirm an upside breakout. Then I’d consider buying. This market has seen a pattern of consecutive higher highs and higher lows for several sessions, which is bullish. However, if the market violates this pattern, exercise some caution. If you take a long position, I would recommend exiting the trade if this market closes under $652, so use a stop close-only at that price. I would then look for another opportunity.


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Crude Oil

As I examine the candlestick chart for NYMEX May crude oil futures, I will point out that I also look for doji patterns, which occur when the opening and closing prices are the same. That means market forces are very indecisive about the future, and often these patterns occur after extended trends. These doji patterns have occurred in the chart of crude oil. There is also a divergence evident, which occurs when the rate of change oscillator isn’t confirmed by price action. There was a +3 reading in the oscillator on February 1, 2007, what I see as an extreme reading, but the market made lower lows on March 2, setting up the divergence. When I see that on the chart, it is a warning signal to me that the market’s trend may be exhausting itself. There was also a doji pattern March 2 with follow through lower price action. The day after the doji, the market closed below the doji low, a very negative signal. I’m not actually saying I’m really bearish on crude oil right now, but I wanted to show how the divergence pattern stands out, and how it can be a warning indicator. A more common momentum indicator, slow stochastics, didn’t pick out the divergence like the rate of change oscillator did.

If I had to take a stand right now based on the technical picture, my bias would be inclined to be short, but this is a short-term strategy. I don’t think crude is going to $50; I’m not quite that bearish. For me to get bullish crude oil, I’d like to see a closes above the adaptive moving average at $60.60, with the rate of change oscillator pointing up. I’d put my stop on a long position below $58.80.

Copper

Everyone is talking about demand prospects from China for copper, as the nation is the world’s largest user. Copper is a key building material, and in China, they need copper to build their infrastructure. In 2006, China’s copper consumption accounted for about four million metric tons, or 22 percent of world supply.

From a technical perspective, the chart of May COMEX copper futures shows the oscillator is at -5, its lowest reading since back in June 2006. The last time the reading was this low, the market saw a nice rally. While this might seem like a bullish signal, I would caution that there is a divergence--the last new high was not confirmed. So, I’m not going to buy or sell just based on this indicator; I would wait for confirmation of a signal to initiate a trade. I’d like to see closes below $2.95 or $2.9210 per lb to sell this market, based on the divergence I see. But if the oscillator keeps going higher, obviously, the divergence will disappear.

Corn

We have another divergence in the corn market, and starting in late February of this year, we saw a three-variable set up. First, the market posted a higher high in price, but with a lower value in the oscillator. Second, there was a negative candle the next day, a bearish engulfing line after an extended rally. Third, the market closed below the adaptive moving average at $4.40 ½ per bushel. When I see this type a three-variable sell setup, that’s strong confirmation of the trend, and that’s when I’d recommend you can trade a little more aggressively than you might otherwise.

As far as a strategy, I’d want to see closes above the adaptive moving average at $4.01 ½ in May corn to get excited about being long.

S&P 500

I’m bullish this market, and I feel the correction we had earlier this month due to sub-prime mortgage fears was overdone. I think June S&P 500 futures will have a chance to continue rallying over the next couple of weeks, and if you initiate a buy, I’d recommend putting a stop 1375. Normally, I don’t like risking that much on any type of trade, but I think you have to give this pattern time to gel. On the other hand, a close below 1402 – 1407, the adaptive moving average, would make me concerned about my long position. I want to see higher highs and higher lows, with a fill of the gap at 1461 over the next couple of weeks as confirmation of a longer-term bullish trend. The chart does show a divergence, with a low March 13 at 1375.90, and a higher value in the oscillator. That tells me the low was a fake out, and that’s a reason I’m bullish now.

As I analyze the markets, I can’t stress enough that my opinion is based on current information, and can and does change. New fundamental information would make me adjust my positions, and as we all know, the information flow is global, instantaneous, and 24-hours a day. So keep an eye on the news, an eye on your charts, and two on your trades.


About Today's Author:

Blake Robben is a Senior Market Strategist with Lind Plus, Lind-Waldock's broker-assisted division. He helps clients develop a game plan that is suitable for their risk tolerance level, and emphasizes following market trends with strict money-management techniques.

Blake utilizes technical analysis strictly on stock indexes, interest rates, and currencies. He incorporates fundamental analysis in the grains, livestock, metals, softs and energies markets, and uses technical analysis to time entry and exit points. He examines weekly charts to gain a long-term perspective on where the market has been and where it may go, and then analyzes daily and intra-day charts to time entry and exit points.

He can be reached at 800-266-0551 or via email at brobben@lind-waldock.com.