By John Hayden
Another tools I prefer to use to indicate trend is moving averages, the standard workhorse used by most technical traders. Moving averages are valuable, as they will remove the volatility from whatever they are calculated from. For example, calculating a moving average based on the RSI, effectively removes the volatility and gives a smoother signal. In fact, the trend can be confirmed by calculating a 9 period simple moving average and a second 45 period weighted moving average on both the RSI and price.
When the:
- The 9 period on price is above the 45 period on price, and
The 9 period on RSI is above the 45 period on RSI the trend is up .
- The 9 period on price is below the 45 period on price, and
The 9 period on RSI is below the 45 period on RSI the trend is down.
- The 9 period on price is above the 45 period on price, and
The 9 period on RSI is below the 45 period on RSI the trend is sideways to up .
- The 9 period on price is below the 45 period on price, and
The 9 period on RSI is above the 45 period on RSI the trend is sideways to down.
Since the RSI is more volatile than the price, the 9 period simple moving average (SMA) on RSI will cross its respective 45 period weighted moving average (WMA) before the 9 period (SMA) on price will cross its respective 45 period moving average. I place more emphasis on the moving averages based on price than those based on RSI. Staying aware of what the moving averages are doing will help you to stay focused on the overall trend. When I am talking to another trader, I will often say that the moving average on price is positive.
This implies that the short term, 9 period SMA is, above the longer term, 45 WMA. The largest moves will frequently come when both moving averages are moving in the same direction. One more thought on moving averages. You will find the moving average 45 WMA will prove to be support or resistance on both price and RSI. For example, you will often see a bullish market retrace to its respective 45 period moving average (price and/or RSI). When t his is observed it is another sign of what the trend actually is.
Here is an example of the U.S Treasury 30 year bond:
It is obvious that the trend has been down since the beginning of 1999. However, by applying the above rules we can see the following. At (1) (with the close at: 124^14), the price found resistance at the 45 period moving average (the red line). Also, notice that the 9 period moving average (the green line) on the RSI crossed under the 45 period moving average thereby resuming the down trend . At point (2) (122^09) the trend changed to sideways to down , thus preventing us from looking for a place to get long. Instead, it forced us to look for a place to get short. This became obvious at point (3) (120^04) where the trend went back to down. The trend shifted back to sideways to up at point (4) (114^20). After the rally to (A), many traders began to believe that the price would continue higher. At (A) several things are occurring. First, the trend is now up , as the moving average on price, and the RSI are positive. Second, the RSI is unable to overcome the 60-resistance level. Third, the price is not able to distance itself from the 45 period moving average on price. This is indicating that the probable direction would remain down. Moreover, the following decline into early August shows that the RSI broke possible support at 40 – indicating probable lower prices. Shortly afterwards at (6) (111^03), the trend turned down again. Between points 5 (114^26) & 6 (111^03) the moving average went positive, and negative a couple times. However, notice that the RSI continued to respect the 60-resistance level, and the moving average on price continued to be negative. Then at point (6) (111^03) the trend resumed its downward trend . At point (7) (103^19) the trend briefly went to sideways to down ; however, it was a false move. This was evident because the RSI was finding resistance at the 40 level – the fact that the 40 level acted as support in late August was also significant. Remember that in a bear market, what was support will often become resistance on a subsequent rally. This was signifying the probability of a major downward move in price.
