The Triple Moving Average System

The triple moving average crossover system is used to generate buy and sell
signals. Its buy signals come early in the development of a trend, and its sell
signals are generated early when a trend ends. The third moving average can
be used in combination with the other two moving averages to confirm or
deny the signals that they generate. It thereby reduces the chance that the
investor will be acting on false signals..

The shorter the moving average, the more closely it follows the price trend.
When a stock begins an uptrend, short-term moving averages will begin rising
far earlier than longer-term moving averages. For example, if a stock
declines by equal amounts each day for 50 days, and then begins to rise by
the same amount each day for 50 days, the 5-day moving average will start to
rise on the third day after the change in direction, the 10-day average will
begin to rise on the sixth day after the change, and the 20-day average will
begin to rise on the eleventh day. The longer a trend has persisted, the more
likely it is to continue persisting, up to a point. Waiting too long to enter a
trend can result in missing most of the gain. Entering the trend too early can
mean entering on a false start and having to sell at a loss. Traders have
addressed this problem by waiting for three moving averages to verify a trend
by aligning in a certain way. To illustrate, we’ll use the 5-day, 10-day, and 20-
day moving averages. When an uptrend begins, the 5-day moving average
will start rising first. Traders view this as interesting but of no major
significance. As the upside momentum increases, longer moving averages
gradually begin to follow suit.

A buying alert takes place when the 5-day crosses above both the 10 and the
20. That is, the average price of the stock over the last five days is greater
than its average over both the last ten days and the last twenty days. This
shows a short-term shift in trend. A buy signal is confirmed when the 10-day
then crosses above the 20-day. The 10-day average price of a stock is more
meaningful than the 5-day average price. If the average price over the last ten
days is greater than the average price over the last twenty days, the shift in
momentum is considered to be much more significant. Conversely, when an
uptrend changes to a downtrend, the first thing that happens is that the 5-day
declines below the 10-day and 20-day averages. This constitutes an alert that
a sell signal may be forthcoming. The confirmed sell signal occurs when the
10-day crosses below the 20-day resulting in an alignment in which the 5-day
average is below the 10-day average and the 10-day average is below the
20-day average. More aggressive traders often use the alert crossover as the
actual sell signal because it locks in more of the profit. However, the risk of
doing this is that the stock may only be "catching its breath" before continuing
its advance. The confirmed sell signal could then take place at a much higher
price. Therefore most traders consider the sell signal to be generated by the
10-day crossing below the 20-day.

I recommend using the 5-day moving average as a filter for each crossover
event. That is, alignment can be used as a tool to reduce whipsaws. For a
buy signal, the appropriate alignment is for the 5-day average to be above the
10-day, and for the 10-day to be above the 20-day. For a sell signal, the 5-
day would be below the 10-day and the 10-day below the 20-day. If the 10-
day has just given a buy signal by crossing above the 20-day average, a
trader might abstain from making the purchase if the 5-day is now declining or
below the 10-day average. The purchase would be made only if the 5-day
resumes its ascent or is above the 10-day average while the 10-day average
is still above the 20-day average. If the 10-day average gives a sell signal by
crossing below the 20-day average, the trader might abstain from selling if the
5-day average has turned and is now rising, or if it is now above the 10-day
average rather than below it. The sale would be made only if the 5-day
resumes its decline or falls below the 10-day average while the 10-day
average is still below the 20-day average. Our stockdisciplines.com traders
have learned through experience that using the 5-day average in this way can
dramatically reduce whipsaws (untimely and unnecessary buying and
selling). The reason these alignments are important is because the shorter
moving average is extremely sensitive to the development of a counter-trend
in the stock’s price. If a trend counter to the trend indicated by the crossover
of your major moving averages is developing, it makes sense to wait for that
counter-trend to dissipate before taking action.

Investors and traders might be wise to incorporate another indicator into their
decision-making. To increase the reliability of the signals given by the system
outlined above, it might be wise to use the 50-day moving average as a
context and reference. The best and most profitable time to buy a stock is
early in a new trend. Later buy signals carry greater risk that the stock will
soon decline (because stocks don’t go up forever). Therefore, if the 50-day
average has been in a significant decline and is now leveling off or just
beginning to rise, a buy signal using the triple crossover method outlined
above has a greater chance of success than if the 50-day average has been
rising for a long time, or is beginning to level off or decline after a prolonged
advance. In other words, the intermediate-term 50-day average can be used
to confirm and "support" the signals given by the shorter-term moving
averages. Generally, it’s better to avoid buying a stock if its 50-day moving
average is in decline. A short-term trader might make an exception to this
general policy in order to profit from a snap-back toward the declining 50-day
average from an extreme oversold condition. When a stock is not trending (when
it’s going sideways) the moving averages will intermingle and repeatedly crisscross
each other. Here, the actual crossovers become worthless as buy or sell signals.
However, the condition represents either consolidation or distribution. Thus, traders
may look at these times as foundations for good entry or exit points, depending upon
their conclusions about what the stock is most likely to do next or on specific
breakout behavior. Various chart configurations (rising triangles, flags, etc.) can give
clues about the stock’s probable behavior once it begins to move again. The reader
can also get hints about a stock’s inclination by observing whether the volume
increases or decreases when the stock’s price rises or falls. For example, if volume
increases on down days and declines on up days, the stock is announcing its
determination to go down, and so on. The volume gives clues about the direction of
stock movement to which money is being committed. Finally, the trader can simply
wait for the stock to "show its hand" by breaking through support on the downside or
through overhead resistance on the upside. In either event, the move is not very
trustworthy without a significant increase in volume.