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Part V. Using Moving Averages. Displaced MA

Using Moving Averages. Displaced MA - Forex School

Commander in Pips:
 : So, let’s finally shift to the application of Moving Averages. As we’ve already said in the previous part, we may use an MA for trend estimation. The simplest way to use it is as follows:

1. If market shows close above some MA – the trend is bullish;

2. If market shows close below some MA – the trend is bearish.

You may use different variations of this strategy.

use different variations of moving average strategy - Forex School
For example, you may apply not single close, but two or three closes above or below and so on. The point is that the overall strategy doesn’t change. But here I want to note a very important feature of any MA:

1. MA is a lagging trend indicator. It means that first, it based on some preceding price action, and, second – it needs some time to react on this price action;

2. This lead us to next conclusion – since an MA lags after the market and when the market changes direction fast and often compared to the MA period, it leads to whipsaw price action. Appling an MA for trading in these circumstances could lead to losses.

Pipruit: And, how does it look like – whipsaw?​

Commander in Pips: Look on chart #1 in the rectangle:

Chart #1 EUR/USD 30-min and 12-period SMA
Whipsaw price action - Forex School
Let’s assume that we apply simple strategy, as we’ve said – close above the SMA means trend is bullish, so we buy. Close below the SMA means the trend is bearish, so we sell. Keep in mind here, that with buying and selling we are not just closing our previous position, but also open another one, according to the current trend. I’ve marked on the chart candles with “B”, where this strategy says we should to buy and “S” where we have to sell. So, for instance – take a look at earliest S and B on the chart. First, we sell, then at B point we’ve closed this position and opened a new one simultaneously. So, in the first “B” point on the chart – we have open bullish position. Other words we always have open position in the direction according with the trend. Now let’s move through the chart:

Chart #1 EUR/USD 30-min and 12-period SMA
Trading with an MA could lead us to solid profits in a trending market and losses when the market turns to consolidation - Forex School
Starting on the left-hand side, the first trade gives us a shallow loss, because we’ve sold a bit lower than we bought back. Here we also open a new long position, and this second trade gives us an excellent profit, because the market has not shown any close below SMA till the first “S” in grey rectangle. Here we’ve closed our long position and entered short. And here our problems have started – all trades in the rectangle have ended with a loss. I intentionally link the price action with a line, just to show you, why it is called whipsaw… Since SMA is a lagging indicator it is just not hasty enough and can’t react quickly to fast changes in market behavior in time. This leads us to loss. Here is the conclusion:

With assumption that SMA period is constant and we do not change it depending on price action (trending or ranging), trading with an MA could lead us to solid profits in a trending market and losses when the market turns to consolidation.

The second problem is a possible unwelcome short time splashes in trend that are also called as fake outs. Here is what it looks like:

Chart #2 EUR/USD 30-min and 12-period SMA
The second problem is a possible unwelcome short time splashes in trend that are also called as fake outs - Forex School
See, the potential profit without the fake out was pretty, but due to some reason, the market has penetrated the SMA (may be some macro data has been released) and you had have to buy there according to the strategy we have selected, but right after the next bar, the market has returned back and continued the trend down. Here you have to close your long position with a loss and re-enter short again. Although, you will have the profit at the end of this trend, you have passed through a not very pleasant moment during fake out and took some losses there.

Pipruit: And what we can do to reduce the probability of such losses?​

Commander in Pips: The most common approach to this is to use not just one but two MAs on the chart.

Pipruit:
 And what it could give us?​

Commander in Pips: While the faster MA is above the slower MA, the trend is bullish. If it moves below the slower MA, the trend turns bearish. Sometime application of two MAs allows us to avoid unwelcome trades due to fake outs.

Commander in Pips: Look at chart #3. I added a 17-period SMA (blue line). Here you can see that during the fake out – 12-period SMA (green line) was clearly below 17-period SMA. Hence the trend was stably bearish, and you have not made any trades there although price has penetrated as 12-period as well as the 17-period MA.

Chart #3 EUR/USD 30-min, 12-period (green) and 17-period (blue) SMA
Sometime application of two MAs allows us to avoid unwelcome trades due to fake outs - Forex School
Pipruit: Looks like it is very useful tool. I should remember that.​

Commander in Pips: I think so. As always, you may combine this method with trend lines and others tools to clearly see if you should you buy or sell. Also, it may be you will find useful to apply not two but three MAs. If they will stand in order – fastest above slowest in uptrend or fastest below slowest in downtrend, you will understand if the pair is in an uptrend or downtrend.

Displaced Moving Averages - special case

Commander in Pips: Here I want to share with you with a very useful tool. It is called a Displaced Moving Average. But first – take a look at chart # 4:

Chart #4 GBP/USD weekly and some SMA
A very useful tool, it is called a Displaced Moving Average - Forex School

Tell me, what do you see here?

Pipruit: Well, I see some MA (green) that in general holds trend nicely, but still was penetrated by 4 fake outs. And some other MA (red) that was not. Possibly the red MA has longer period then green MA. Looks like applying red one could lead to better results…​

Commander in Pips: And what will you answer if I say that both MAs have the same period…

Pipruit: And how it could be possible?​

Commander in Pips: Yes, both MA are 7-period MA, but red one was displaced forward for 5 periods:

Chart #5 GBP/USD weekly, 7-period SMA (green) and 7x5-period (red) DMA
GBP/USD weekly, 7-period SMA (green) and 7x5-period (red) DMA - Forex School
You can see, that although both of the MAs have the same period – “7”, the Displaced SMA (DMA) does a much better job holding up against occasional splashes (fake outs) on the weekly chart. Due to this property, by using a DMA you can stay in a “sell” position without interruption, while using 7-period SMA without displacement – you have had to reestablish shorts at least 3 times due to fake outs.

Pipruit: Cool! And what is displacement, how to apply it via software?​

Commander in Pips: Usually, if software allows you to make displacement of MA, there should be some field for entering the number of periods that you would like to displace the MA in tweaking procedure of MA drawing. This field could have different names – “Offset”, “Shift”, “Displacement” – are most common to see.

If you want to shift (displace) MA forward – you should enter a positive number. In our example we’ve shifted 7-period SMA for 5 period forward;

If you want to shift (displace) MA backward – you should enter a negative number.

Pipruit: And what does displacement mean?​

Commander in Pips: Imagine that you put tracing paper upon the chart with simple MA (green line), then ink this SMA on tracing paper. And finally shift tracing paper for some period forward or backward, i.e. across the time scale (x-scale). It’s like a parallel shift. The shape of MA remains the same, but it is just moved forward or backward for some periods. If you look at chart #4 or #5 you’ll see, that the shape of both MAs are the same. If we move the red line back for 5 periods it will totally coincide with green one.

Pipruit: Oh yes, I think I’ve got it! Once in childhood, I built a tower with blocks, but then mother has asked me to move it, because she washed the floor and my tower was in her way… But I didn’t want to break the tower, so, I very cautiously shifted it parallel for a couple of meters sideways without breaking it. Is it something similar?​

Commander in Pips: Yes, treat the MA as your block tower, and displacement as your shifting for a couple of meters. So the tower (i.e. MA) is the same, but is placed forward for some periods.

Pipruit: I see. And why are you so fascinated with DMA?​

Commander in Pips: The first reason, I’ve already shown to you – it safer to use during fake outs.

Pipruit: But wouldn’t is be the same, if we will use SMA with a bit longer period?​

Commander in Pips: No, this will not be the same – take a look:

Chart #6 GBP/USD weekly, 7-period (green), 18 (blue) SMA and 7x5-period (red) DMA
GBP/USD weekly, 7-period (green), 18 (blue) SMA and 7x5-period (red) DMA - Forex School
First of all, take a note that period of second SMA (blue) is almost two times greater than our DMA, and during the trend they coincides. But take a look at rectangles – see, the blue line of 18-SMA gives later signal than our 7x5 DMA (we will mark it like that - “7” stands for period and “5” stands for displacement – 7x5).

It means that when you will fix profit from this trade, the DMA will give you better results than the 18 SMA, because it gives an earlier signal to buy – market penetrates the 7x5 DMA earlier than the 18 SMA. And 7x5 DMA will save you from fake outs. Impressive, ah? This effect will be even greater, if you will use longer periods for MA.

Pipruit: And does it always occur like that?​

Commander in Pips:
 Of course not – even a DMA could fail in a whipsaw and some significant fake outs. But in general, it gives better results than an SMA. It is needless to say that before applying any DMA you will have to estimate the optimal period for it on a particular market. If you will use random numbers for periods without any relying on some investigation of particular market or Forex pair – you are doomed – even a DMA will help you. Application of any tool on the real market demands detailed analysis for suitability of possible tunings of this tool to the particular market. As a result, it is very probable that you will come to using of different numbers for different pairs and markets. For instance it could turn out that after some analysis you will use a 7x5 DMA for EUR/USD and a 10x3 for GBP/USD. Furthermore, I’m sure that you will use different periods for different time frames…

Pipruit: Thanks, I’ll remember that. And can we displace an EMA or other types of MA, or displacing is only for SMA?​

Commander in Pips: You can displace any of the types of MA. Displacing does not change the nature of an MA. It is just additional parameter in the tweaking procedure – that’s all.

Pipruit: Great, something else?​

Commander in Pips:
 Yes, there is another very useful property, that DMA has and SMA does not. Look at the next chart:

Chart #7 EUR/USD daily, 7-period (green) and 7x5-period (red) DMA
EUR/USD daily, 7-period (green) and 7x5-period (red) DMA - Forex School
We already know that we can’t estimate the value of an SMA by close prices for current period (in our case this is a day), because it has not closed yet, and hence, its close price does not take part in the calculation of an SMA. Now imagine that you trade with an SMA. This fact leads you to a huge problem – you do not know when the trend will change during the day! But with using a DMA – you do not have this disadvantage. Since the DMA displaced forward – it already has a value for the current day and even for tomorrow. So, if you use DMA – then you know the price at which trend will shift in advance – even before the trading day starts!

Pipruit: Huh Commander, you do right, really. Why I didn’t think about earlier… Indeed, using an SMA we do not know its value for today’s trading day, so we do not know when the trend will shift…​

Commander in Pips: So, as you can see, a DMA has a lot of advantages, compares to SMA. DMA is better at holding the trend and has rarer falls in fake outs. DMA shows you buy or sell signals earlier than asimilar SMA, but with greater period. And finally, a DMA shows you precisely the value ahead of time – for the current trading period and even further. That’s why I like DMA. I suggest you should try it, even if you turn back to SMA then.

Pipruit: You’re absolutely right, I definitely will do it. But can we use SMA, and still have its value for current session somehow?​

Commander in Pips: Well, there is one decision – you may build an SMA based on open prices, instead of close prices. In this case – you will have it, but I didn’t check how useful this method is on real markets. Here you should try by yourself.

So, as a shallow conclusion I can say:

1. I prefer to use DMA instead of SMA due to the qualities that I’ve said already;

2. To my mind, there is not any great advantage between displaced EMA over SMA (at least for me). That’s why I use displaced SMA.

3. Here some numbers to start – Joe DiNapoli uses followed displaced SMA: 3x3; 7x5; 25x5. 3x3 is for the short term trend, 7x5 for the medium term and 25x5 for the long term trend estimation. Maybe these numbers will be useful for you, at least you can start your own analysis with them, and later correct them according to your own trading style.

4. Also, as you understand from our discussion, the major advantage with any moving average is in simplicity of their application. You do not have to make some difficult calculations or observations for telling what trend is it currently – upward or downward. It will be enough just to estimate where is the close price – above or below some MA.

Comments

Benjamin Lam
7 years ago,
Registered user
Displaced MA

Hi Commander,
Read the lesson on Displaced MA but confused. On the MT4 platform under Indicators-Moving Average, we can only find SIMPLE_EXPONENTIAL_SMOOTHED n LINEAR WEIGHTED but cant find DISPLACED MA.
Also whai is the meaning of "Yes, both MA are 7-period MA, but red one was displaced forward for 5 periods:"? Does this DISPLACEMENT mean filling in the "SHIFT" box of the MOVING AVERAGE box?
"- If you want to shift (displace) MA forward – you should enter positive number. In our example we’ve shifted
7-period SMA for 5 period forward;
- If you want to shift (displace) MA backward – you should enter negative number." does this mean, say, positive # is 5 n negative # is minus 5?
Tks.
Sive Morten
7 years ago,
Registered user
> Hi Commander,
Read the lesson on Displaced MA but confused. On the MT4 platform under Indicators-Moving Average, we can only find SIMPLE_EXPONENTIAL_SMOOTHED n LINEAR WEIGHTED but cant find DISPLACED..

Yes, on both questions.
You have to fill "Shift" field in MT4 MA, and what type to use - simple, exp, or smoothed - this is quite different parameter. In our examples we use simple displaced MA.
So, if you want in MT4 build 7x5 DMA, you need choose 7-period, shift =5, type - simple.
jmcl
7 years ago,
Registered user
Lots to study

Hi Commander

Thanks for ALL this valuable information.

Just interest to know what platform are you using in the examples?

My concentration is more focused now after studying the insets here.

Regards

John from Durban
Sive Morten
7 years ago,
Registered user
> Hi Commander

Thanks for ALL this valuable information.

Just interest to know what platform are you using in the examples?

My concentration is more focused now after studying the insets here.
..

Hi Jonh,
this is CQG trading platform. It rather expensive, so it make sense to use it, if your rather successful trader and your assets somewhere 100K+
This is one from "Big three" - Bloombers, Reuters and CQG. But among all of them - only CQG has full DiNapoli indicators pack
Amon Mitch
7 years ago,
Registered user
Dear Sir,

Doesn't the use of Smoothed MA (MT4 Platform) do a better job of reducing the whipsaws?

I mean a comparison between 7x5 SMA and 7x0 SMMA (Smoothed Moving Average)

Thank you
Sive Morten
7 years ago,
Registered user
> Dear Sir,

Doesn't the use of Smoothed MA (MT4 Platform) do a better job of reducing the whipsaws?

I mean a comparison between 7x5 SMA and 7x0 SMMA (Smoothed Moving Average)

Thank you

Hi Amon,
let me know this :)

Using smooth MA, exponential or simple without displacing, still will be significantly different from displaced one.
But, it's very personal. Still, SMMA will be closer to SMA than to DMA. From that point of view, it hardly will be better than DMA.
jmcl
7 years ago,
Registered user
> Hi Jonh,
this is CQG trading platform. It rather expensive, so it make sense to use it, if your rather successful trader and your assets somewhere 100K+
This is one from "Big three" - Bloombers, R..

Thanks Sive

I am not there yet, but learning hard

John from Durban
FOREXHAWK
7 years ago,
Registered user
hi Sive

I have just aquired Metatrader 4 and revisited your lesson on DMA's having placed a 7sma and 7x5sma. The end of both averages give the same reading on the EUr/US chat for 1day. I can clearly see that your example shows the displaced SMA being slkightly higher th the SMA. the readings are 1.37112 on the displaced and normal SMA this is trending down with cadles retracing back from a swing low at 1.35008

Could you please advise me why this has occured am I doing something wrong
Sive Morten
7 years ago,
Registered user
> hi Sive

I have just aquired Metatrader 4 and revisited your lesson on DMA's having placed a 7sma and 7x5sma. The end of both averages give the same reading on the EUr/US chat for 1day. I can cle..

Hi Hawk.
It's a bit dufficult to understand only by speaking about it. COuld you please attach the chart and parameters of MA's that you've plotted.
DMA and SMA should have the same last number, since DMA is just horizon parallel shifting of SMA for some period forward or backward.
Hamza Samiullah
2 years ago,
Registered user
Nice Explanation...
One-fm
8 months ago,
Registered user
quite explicit.

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