One of the keys to discretionary trading success is knowing when not to trade. Here’s a simple chart pattern that can help filter out some of the good times from the bad, and it works on pretty much any market or any timeframe. Take a look at the recent action in the S&P 500 index (daily chart, 24 hour session):
Here’s the simple rule: when a market spends a lot of time around an intermediate term moving average, the market is probably in relative equilibrium. Since every edge we have, as technical traders, comes from an imbalance of buying and selling conviction, those are markets in which we do not want to participate. Those are markets that are likely to be more random, and random price movement is what slowly grinds our trading accounts, and our mental fortitude, to dust.
Now that’s the broad concept, but I’d recommend you refine it a bit and make some firm rules before you use it. Consider the first sentence of the previous paragraph; you need to define at least the following concepts: 1) what’s “a lot of time”? How many bars does the market need to spend around the moving average? 2) What does “around” mean? In the example above, it was clear because the market chopped back and forth through the average, but is there a more precise definition you could use? 3) What kind of average and what period will you use? 4) How do you boil this down into trading rules? 5) Might those rules be different if you were thinking of entering a position or already in a position?
In general, I think most of the things people do with moving averages do not make sense. Moving averages do not provide support and resistance; that’s an illusion you are seeing on the chart and it isn’t real. There are no special moving averages; the 200 day is no more important than, say, the 190 day. (Read more here.) Moving averages, crossing of various moving averages, slopes of moving averages–none of these work as reliable trend indicators. But here’s something that does work. What we are looking for is not a specific signal from a magic number, but a broad concept: when a market is moving relatively sideways, there’s quite likely no edge. We can avoid being in that environment and wait for better trades–a good use of both mental and emotional capital. This is a way to use a technical tool to illustrate the broad concept, the underlying mood of the market, and then you can craft trading behavior to match the mood of the market.
This isn’t a profound trading rule, but it is another one of those little things that can make a big difference. When you have a lot of those little things aligning in your trading, you have the difference between success and failure.