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Don't Use Moving Averages! Use This Instead — Transcript

by FXStreet · 2,816 words · 430 segments · language en · Watch on YouTube

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0:00Look at this. The market has already
0:02moved significantly before the moving
0:05average crossover appears. It doesn't
0:08work. And I want to show you an
0:10alternative that does. [music] In this
0:12video, I'll show you why I stopped
0:14relying on moving averages to define a
0:17trend. We'll see when moving averages
0:20fail, then break down a different
0:22indicator. Imagine an indicator that
0:25adjusts your trailing levels as the
0:28trend develops. Because a late signal
0:30can mean entering after the move and
0:33taking unnecessary risk.
0:36One of the first subjects you are taught
0:38in technical analysis is the moving
0:41average. An easy to calculate and easy
0:44to learn indicator.
0:47The simple moving average is a
0:49calculation of the average closing price
0:52of an asset over a set period of time.
0:55To find this indicator on Trading View,
0:58simply click on the indicator list,
1:00start typing the name and it will
1:02appear. And you can adjust the period
1:05from the length box in the settings.
1:12As the name says, it's simple. On this
1:16chart, we have the average closing price
1:18of gold over a 20-day period. A similar
1:21but slightly different indicator is the
1:24exponential moving average or EMA.
1:28This is the preferred indicator for many
1:31traders for its mildly reactive nature
1:34at the near end. The EMA gives more
1:36weight to recent prices, making it more
1:39responsive to recent price changes than
1:42a simple moving average. Traders use
1:44various time settings to define short,
1:48medium-term, and long-term trends. They
1:51might look at a combination of moving
1:53averages such as the 10, 20, and 50.
1:57Above 10 and we are shortterm bullish,
2:00above 20 and we are medium-term bullish.
2:03Above 50 and we're long-term bullish.
2:07The opposite applies. Then we have the
2:10moving average crossovers. This is a
2:13technique for taking a buy or sell trade
2:16when two or more moving averages cross
2:19each other. And well-known swing trading
2:22signals are the death cross and the
2:25golden cross. The death cross occurs
2:28when the daily 50 simple moving average
2:31moves lower through the 200 simple
2:34moving average. This is interpreted as a
2:37bearish signal for the long-term trend.
2:41And the golden cross occurs when the
2:42daily 50 simple moving average moves
2:45higher through the 200 simple moving
2:48average. This is interpreted as the
2:51long-term trend turning bullish. But
2:54here is the biggest problem. The moving
2:57average crossover is one of the worst
2:59lagging indicators.
3:02This means it happens a long time after
3:04the move is underway. And in a moment,
3:07I'll show you on the chart just how late
3:09that signal can be and how much risk
3:13that can create for traders. Look how
3:16much this lags the market. Spot gold
3:19made a top of $5,62
3:22and the signal was at $4,088.
3:26And look at this scenario in the euro
3:29against the US dollar. The price made a
3:31bottom at 1.0178
3:35and the golden cross that was at 1.1396.
3:40In both scenarios, the market had
3:42already reversed before the crossover
3:44confirmed the move. Many swing traders
3:47will place their stop loss above the
3:49swing high or below the swing low. And
3:52the stronger and more extended the trend
3:54becomes, the further away your stop loss
3:57may be from your entry depending on the
3:59strength of the trend. This can result
4:02in excessive risk. So, can we use an
4:05indicator that dynamically adjusts to
4:08the trend rather than simply averaging
4:10what has already happened? In the next
4:13[snorts] part of the video, I'll show
4:15you the parabolic zar and how it's
4:17moving dots can help you stay with a
4:19trend as the move develops. The
4:22parabolic stop and reverse was developed
4:25by J. Wells Wilder. He's the same person
4:29who developed indicators such as the
4:32relative strength index, the average
4:34true range, and the ADX, which is the
4:37average directional index. He has an
4:41extensive CV. The parabolic ZAR is
4:45essentially a trend following and
4:47trailing stock mechanism that is based
4:49on price and time. And if you've been
4:52watching any of my other videos, you
4:55know how much emphasis I have on time.
4:59What does the parabolic zar actually do?
5:02On this chart, you will see a series of
5:04dots. The dots are generally below price
5:08in an uptrend and above price in a
5:11downtrend. A very basic interpretation
5:14is dots below the price and we are in a
5:18bullish trend. Dots above the price and
5:21we are in a bearish trend. Now here is
5:24the really interesting part. When the
5:26[snorts] dots switch from one side of
5:28the price to the other, the parabolic
5:31zar produces a stop and reverse signal.
5:36Simple enough to understand, right? So
5:38consider the difference this way. The
5:41moving average tells you the average
5:43price over X periods. The parabolic zar
5:47tells you where your stop should be
5:49based on the direction, duration, and
5:53acceleration of the trend as the trend
5:56develops. But why does [snorts] the
5:58distance between the dots and the price
6:00keep changing? That's where the really
6:03interesting part of the indicator comes
6:05in. Two important factors we've yet to
6:08discuss, duration and acceleration.
6:13But let me clear those up now. The
6:15indicator is called parabolic because
6:18the stop and reverse system accelerates
6:20as the trend develops. Imagine a price
6:23starting to rise. Initially the zar dots
6:27will move upwards relatively slowly but
6:31as the trend continues the indicator
6:34accelerates towards price. If the price
6:37then reverses through the zar the system
6:40flips direction. The accelerating
6:43feature is what gives the indicator its
6:46parabolic character. And this is the key
6:49difference in how to use it. Instead of
6:51waiting for two averages to cross, the
6:54parabolic zar continuously adjusts its
6:57trailing level as the trend develops.
7:00Let's look under the hood and see how
7:02that actually works. This is where the
7:05parabolic zar gets interesting. Let's
7:08look at the calculations behind the
7:09indicator. We use three key concepts.
7:14Number one is the zar, the current stop
7:17and reverse value. Number two is the
7:20extreme point. The most extreme price
7:23reached during the current trend. So in
7:26an uptrend, the extreme point is the
7:28highest high reached during that trend.
7:31And for a downtrend, the extreme point
7:33is the lowest low reached during the
7:36trend. And thirdly, we have the
7:39acceleration factor. This controls how
7:42quickly the ZAR moves towards the
7:44extreme point. The standard settings are
7:48starting acceleration factor 0.02,
7:53increment acceleration factor 0.02,
7:57and the maximum acceleration factor of
8:000.2. The basic formula in an uptrend is
8:06so if the market continues making higher
8:09highs, the extreme point increases and
8:12the acceleration factor can increase as
8:15the new extreme points are recorded,
8:18causing the ZAR to move progressively
8:21closer to price. A simple example,
8:24suppose you're in an uptrend. The
8:26current ZAR is 100. The extreme point is
8:30120. The acceleration factor is 0.02.
8:35Then the calculation is
8:40zar equ= 100.40.
8:44So the zar moves from 100 to 100.40.
8:50Now suppose the price makes another new
8:52high and the extreme point becomes 125.
8:57Because a new extreme point has been
8:59established. the acceleration factor
9:01increases from 0.02
9:04to 0.04
9:07then the calculation is
9:11that equals 101.38.
9:15The ZAR is moving faster. If the trend
9:19keeps making new highs, the acceleration
9:21factor keeps increasing until it reaches
9:24its maximum.
9:26And this acceleration factor is actually
9:29the secret behind the whole indicator as
9:32it determines how aggressively the ZAR
9:34moves towards price. In the next few
9:37minutes, I'll show you how it makes the
9:39ZAR tighten your stop as the trend
9:42develops. This is what makes the
9:44parabolic ZAR different from the simple
9:47moving average or the moving average
9:49crossover. It is talking to us. It says
9:54the longer the trend continues and the
9:56more extremes it makes the more
9:58aggressively I will move my stop towards
10:01price. That is a very clever and unique
10:04concept. You can consider it this way.
10:07In an early trend, the zar gives price
10:10room to breathe. As the trend develops,
10:13we look to tighten the stop. The trend
10:16becomes more mature, so we tighten
10:19further. The price reverses and it hits
10:22the ZAR. This is our trailing stop and
10:25it can be used as an exit signal. But
10:28does this actually solve the problem we
10:30started with? Enough theory. Let's put
10:33the parabolic ZAR head-to-head with a
10:36moving average crossover and let's see
10:38what happens. Let's look at some
10:40comparisons using a simple moving
10:42average of 10 and 20 periods. And the
10:45parabolics are with factory settings.
10:48Let's look at the US dollar against the
10:51Swiss Frank. Here we can see pretty
10:53aggressive move to the upside. Uh
10:55bullish trend. We get a stop and reverse
11:00at the close of this candle. Let's take
11:02a note of that level 0.81
11:06uh49. So that would be uh the initiation
11:10of a stop and reverse um for dollar
11:12Swiss on this uh 1 hour chart. Let's
11:17play it forward. see where we get uh the
11:19crossover for the 10 and 20 uh simple
11:23moving average.
11:26Okay, so it's on uh this candle here.
11:28That's the close of that candle which
11:31comes in at [clears throat]
11:330.8128.
11:36We'll continue uh to uh press the uh
11:39replay button on the Trading View chart.
11:44The trend moves to the downside. Okay,
11:47on this candle, we would actually get
11:50out of uh the parabolic ZAR. So,
11:53obviously trailing the stop lower the uh
11:56ZAR levels getting closer to the price
11:59as the trend uh accelerates to the
12:02downside. And this is actually the
12:04candle that flips uh or initiates uh the
12:08trailing stop. Let's see the level for
12:12that candle. So that's I would say 8087
12:16uh 8088.
12:18Let's play forward again to see what
12:21happens uh with the moving average
12:23crossover.
12:27Okay. So that happened
12:29the close of this candle uh which comes
12:32in at 0.8079.
12:35So you can see here in this scenario um
12:39we actually got into uh this trend a lot
12:42earlier uh than the moving average
12:45crossover. But it also got us out of
12:48this trend uh a fair bit earlier uh than
12:51the moving uh average crossover. And in
12:54fact entering here and exiting here is a
12:5862 pip uh range.
13:01taking a short position here and coming
13:03out at this level and the close of that
13:06candle is 49 pips. So actually the
13:09parabolic zar uh is a 20%
13:14better result without taking uh the
13:17spreads into consideration which should
13:19be uh the same but a 20% better result
13:22using the parabolic z than using the
13:25moving average crossovers.
13:28Okay, similar picture. This is the US
13:30dollar against the Canadian dollar. We
13:32see quite an established uh bullish
13:34trend. Uh moving average crossover here
13:37yet to cross back. Um the ZAR would have
13:42put you into a long trade around about
13:44um 1.3862
13:46and then taken you out in this period of
13:48consolidation uh up here. Um
13:52the price flip. So we've got the ZAR uh
13:55initiated on this candle. Let's have a
13:58look at the price level.
14:01So, coming in around about 1.3917
14:05uh would be the entry if you decided to
14:08take a short on uh this uh stop and
14:12reverse. Let's see what happens. Uh
14:14let's see where we get the crossover.
14:18So, an aggressive move to the downside
14:21and the crossover is actually on this
14:23candle all the way down here. Now
14:25remember what we said previously in the
14:27video that depending on how aggressive
14:30the moves can be uh the moving average
14:33crossover can really lag behind price.
14:36So let's see where we
14:39would have uh taken a short entry uh in
14:42this scenario and that comes in at
14:441.3852.
14:47Let's see where we get out of these two
14:48trades.
14:52a decent trend again quite a long way uh
14:56from price action but as the trend
14:58continues uh the ZAR level uh the stop
15:01and reverse tightens up
15:06actually taken us off the page there. So
15:09we would have come out of
15:13the stop and reverse uh here. Let's take
15:16note of that level. We're going to look
15:19to the left hand side cuz it was quite a
15:20tight candle. See what uh that level is.
15:231.3788.
15:26And then where do we get the moving
15:28average crossover? Okay, so the moving
15:30average crossover not too far uh with
15:33regards to uh to distance and that's
15:35coming in at uh 1.3792.
15:39So you can see here the initiation of
15:41the short trade in the US dollar against
15:44the Canadian dollar was a long way in
15:47front of the moving average crossover
15:49and that was because of the aggressive
15:52uh move uh to the downside in uh this
15:56currency pair. And then you can see
15:58period of consolidation. Um the
16:02profit or the trailing stop gets
16:04initiated uh at this level for the ZAR
16:08and you would have uh come out of your
16:11short moving average crossover uh at
16:13this level. So, in comparison to the two
16:18uh trade setup or potential trade
16:20setups, we've got 132 pips on this um
16:25trade, which is the parabolic ZAR. And
16:27on the moving average crossover, it
16:30comes in at 60 pips. So over 100% uh
16:35better result because we saw a strongly
16:39uh trending market and that lagging
16:42moving average crossover um ended up uh
16:46costing traders uh over 70 pips. Okay,
16:50in this example we're going to look at
16:52WTI. That's uh US crude oil. So pretty
16:56mixed volatile price action. Some choppy
16:59crossovers here. Then a bullish trend
17:02again a period of consolidation. But on
17:05this candle here we get the parabolic
17:08zar uh stop and reverse. Let's take a
17:11note of the close of that candle
17:14trading view. If we look over to the
17:16left hand side we can see here uh the
17:19close. If we hover over the candle that
17:20comes in at $86.94
17:24for a long initiation from the parabolic
17:28zar. Let's move it forward.
17:32Okay. So, the crossover happens here.
17:35So, pretty close to uh the ZAR trigger
17:39or the stop and reverse I should say.
17:41So, again coming in at uh the close of
17:45that candle, $87.17.
17:48Let's see what happens. Pretty close
17:50entries for uh both uh the moving
17:52average crossover and the stop and
17:55reverse.
17:57and it moves to the upside. So, we would
17:59have been out
18:02with the trailing stop loss on the close
18:05of this candle.
18:08Let's take note of that. The close of
18:10that candle is at $8854.
18:16The moving average is yet uh to cross
18:19over. So, uh keeping traders uh in the
18:23bullish trend for now.
18:25It makes a swing high
18:28and then comes lower. Uh this is where
18:31we get the crossover. So it's the close
18:33of uh the candle.
18:37Again, look to the left hand side to
18:38take note. The close of that candle is
18:41at $89.71.
18:44So you can see here parabolic ZAR got us
18:47in and out pretty quickly in this
18:50scenario. uh the moving average
18:52crossover uh was here and it got uh got
18:56traders out here. So extended uh the
19:00trend uh to the upside. Neither
19:02performed uh particularly well uh cuz
19:05the aggressive move to the downside um
19:07it took some time for the crossover to
19:10happen from the swing high and you can
19:12see here these two candles um actually
19:15took out the long trade. So, [music]
19:18uh the next uh stop and reverse it was
19:20actually all the way up here. But
19:23calculations for both of these trades,
19:25for the stop and reverse, uh the profit
19:28would have been $1.6.
19:30For the moving average crossover in this
19:34scenario, uh would have been $2.54.
19:38So, an increase in profit of 60% in uh
19:43the moving average crossover. And now
19:46you can see the trade-off clearly.
19:48Moving averages can help define the
19:51broader trend, but their signals, they
19:53can arrive late. The parabolic zar is
19:57designed to dynamically follow the trend
19:59and manage the exit. But if it's so
20:02good, why doesn't everyone use it?
20:05Because like all trend following
20:07indicators or systems, we can get
20:10chopped up in sideways movements. When
20:13the market lacks clear direction, the
20:15ZAR can flip repeatably and generate
20:18false signals. The indicator doesn't
20:20know when the market is ranging. It's
20:23simply doing what it was designed to do,
20:26follow and reverse. That's why I
20:28wouldn't use parabolic ZAR in isolation.
20:31But used in combination with other
20:33technical analysis techniques such as
20:36trading the Elliot wave theory, this bad
20:39boy can get you in early and give you
20:42extended profits. And there we have it.
20:44My preferred indicator for staying
20:47within the trend. But here's the thing.
20:50Knowing when to get out doesn't tell you
20:52how much you should risk in the first
20:54place. And that's where risk management
20:57comes in. Watch the next video that
21:00breaks down the riskmanagement strategy
21:02you need to know.

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