Displacing a Moving Average forward in time offers several significant advantages to the trader.

1. It lets you know what the Trend delineation point or price number will be "N" number of periods ahead of time. Knowing where this point is, ahead of time, helps you to plan your market strategy.

•  By using the "proper" number ofperiods for calculation of the Moving Average and the
"proper" displacement amount, DMAs tend to reduce whipsaws and "cup" or contain
market action in ways that are very helpful to traders.

•  Certain DMAs are extremely useful in defining patterns, as shown in CHAPTER 6,
Directional Indicators.

After many years of research spent selecting the proper length and displacement amount, I have arrived at three DMAs. They are:

•  The 3 period simple Moving Average of the close, displaced forward three periods.

•  The 7 period simple Moving Average of the close, displaced forward five periods.

•  The 25 period simple Moving Average of the close, displaced forward five periods.

For brevity, they will be shown as follows:

3X3, 7X5, 25X5

The periods I use are Daily, Weekly, and Monthly. Quarterly and Yearly periods work equally-well, but I seldom look at those Time Frames.

I've been teaching the use of DMAs for over 11 years. I've answered hundreds of questions on the subject. Since the same questions come up time and again, I think it would be useful to review them.

FREQUENTLY ASKED QUESTIONS:

What do you mean by "displacedforward in time" and how does this help reduce

whipsaws?

Rather than plotting a given Moving Average, calculated today, on today's date, you simply plot the identical value at a different, later date, hence the term "displaced." The displacement is on the time axis, not the price axis. For the visual learners among you, the arrow in the following chart shows that the same Moving Average is simply placed forward in time. All calculations remain identical. For the mathematical types, Appendix A contains a table showing the calculations and where the respective values are placed.

The next Chart 4-2A, shows a mathematically weighted Moving Average, (i.e. various "weights" given to different periods) plotted with no displacement. In other words, the chart shows a standard weighted Moving Average. The number of periods or the character of the weighting is not significant to the discussion.

Chart 4-2B shows the identical Moving Average displaced forward five days. The displacement amount could have been two, three, 10, or minus 10 days, weeks, or months. It is as if you took a piece of tracing paper that had only the Moving Average on it (no price bars), and slid the Moving Average left or right horizontally the desired amount (displacement).

Now, let's assume a basic Moving Average crossover, non-judgmental, always in the market system, where one would buy on close above the MA and sell below it on close. It's easy to see how many times one would have been whipsawed by the non-displaced MA as opposed to the Displaced MA.

For those of you who are attempting to build non-judgmental systems using Standard Moving Averages, try this additional variable and see ifyou get better results.

ADVANCED COMMENTS:

As with most observations in this business, there's the obvious and the insidious advantage to note. Obviously ifyou are whipsawed less often, you'll have a higher equity. Not so obvious is the real life factor of continuing to play the game. By the time most traders reached Q (for quit) as shown above in Chart 4-2A, they would have thrown in the towel and gone back to system development. Of course, this occurs just before the most profitable run on the chart. Point Q on Chart 4-2B has been relabeled to M for money because that is what will be made. The real life truth is that a trader trading off of Chart 4-2B is much more likely to be there for the big gains that are to follow!

Even being whipsawed infrequently, as in Chart 4-3A, can leave an average trader with an emotional excuse not to reenter. Look at the profit you would have missed if the whipsaw in March gave you an excuse to stay out of the market.

Wouldn't using a longer Moving Average period accomplish the same function of preventing whipsaws and keeping you in the market?

Not really. Where a longer MA will likely provide fewer whipsaws, other properties change as well. See Chart 4-3A. Note how the displaced MA and the non-displaced MA approach one another when the market finally breaks. You maintain the same profit level, point P.

The profit differential on Chart 4-3B is a different matter. Here we have a longer term standard MA. It falls dramatically away from market action. Therefore, a non-judgmental system whose signals are based on crossing a MA on close to take an open profit (P2), is likely to give back significantly more than the shorter period DMA would give back (P1).

How would you trade this?

I wouldn't. Trading any given market will come only after this book has thoroughly covered all the aspects needed to trade. The examples contained herein are for your understanding of the segment covered.

What did you mean about blowing the price delineation point 'N' periods forward in time?

The term 'N' refers to the displacement amount. If we're talking about daily periods, the 3X3 is displaced three days forward in time. You know the DMA value of the current day, two days, and three days ahead of time, i.e. the price point that will delineate trend. If there was no displacement (N=0) then you wouldn't even know until the close what the Moving Average value was for the current day, since you need that value to calculate the Moving Average.

Years ago, traders used the opening price rather than the close to calculate the Moving Average value, so they would know ahead of the close what the MA was for the current day. I believe the first series of workshops I gave in 1986 and 1987 discussing the advantage of DMAs was instrumental in the demise of this practice.

What about exponential MAs, weighted MAs, or "back-deviated Maxwell convoluted" MAs? Would they work better? Do the Displaced Moving Averages you use work in all markets?

You're welcome to try them. I arrived at the DMAs cited above over a period of about two and a halfyears, cranking them out on a CPM based computer using an 8088 chip. I studied thousands of charts, in all manner of markets, in all types of conditions. I tried every kind of MA I could imagine and have programmed. In those days there was no commercially available software I was aware of that created DMAs. To accomplish this task I needed to create a graphics package that would displace a Moving Average. The result was the first incarnation of the CIS TRADING PACKAGE, programmed by George Damusis. My research revealed no advantage in more complicated DMAs, over simple DMAs. Therefore in keeping with my primary directive, i.e. keep everything as simple as possible, I stuck with simple DMAs.

It's also useful to understand that I did not go through this optimization process, so popular with many of the computer junkies and cerebral types. Instead, I exhaustively examined market after market, to see what I, as an experienced trader, could live with emotionally and reasonably expect to be profitable. Could I do a better job today? I doubt it. More number manipulation power is not necessarily better. Besides, I doubt I'd have the fortitude to take on such a job today. Even if I were to make this single aspect of my Trend analysis technique 5% better, would it significantly influence the bottom line? I think not. As you will see, Trend analysis is filtered and acted upon by subsequent powerful techniques. Remember the old axiom, if it ain't broke, don't fix it. Don't misunderstand me on this point. Research is terrific. You can learn a lot from it, and you should try to improve on my work if you are so inclined. I would suggest to you, however, that you test your results across all the markets. The DMA values and calculation methods used should have universal applicability (overseas markets) as well as the ability to stand the test of time.

Below is a highly compressed chart of the daily UK long bond (gilt) with both the 25X0 and 25X5 shown. This chart illustrates price action in both trending and consolidating periods. Arrows have been placed at points where the 25X5 contained Trend but the 25X0 did not.

They work very well, but I have a technique that (for me) works better. It's the MACD/Siochastic combination. Many of my clients use DMAs on intraday charts and rave about their effectiveness. You, of course, are free to try them. They are simpler to employ than the MACD/Stochastic combination.

The following chart shows how well an intraday 3X3 contains thrusting moves on the 30 minute S&P.

So how do we define the "Trend"?

Very simply. If the close is above the Displaced Moving Average you choose, the Trend is up. If the close is below it, the Trend is down. If you use DMAs to non-judgmentally enter or exit a market, I'd suggest giving it a tick or two, through the DMA on close, before acting, particularly on the longer term 25X5.

What if the price is above it now, at mid-day, but yesterday's close was below it? In that case, the Confirmed Trend is down and the Unconfirmed Trend is up. Why do you use three value setsfor the DMA ?

The 3X3 is for the short term and is extremely useful in thrusting markets.

The 7X5 is a longer-based DMA that many have found useful in equity market analysis.

The 25X5 is my long term DMA.

What if the closingprice is below the 3X3, but above the 25X5?

Then the short term Trend is Confirmed down and the long term Trend is Confirmed up.

Below is an example of both DMAs on the daily German bond (bund).

How you would react or how you would play this would depend upon what Time Frame player you were. If you were an hourly-based player, you would be very interested in the daily 3X3 and you'd be aware of the 25X5. If you were a weekly-based player, you would be interested in the 25X5 on the daily or perhaps the 3X3 on the weekly. One caveat here. If the weekly-based trader was aware of a Directional Indicator created from a daily-based 3X3, he would take notice. I'll explain this in detail in CHAPTER 6.

Is it okay to take a position on an "Unconfirmed" signal?

Absolutely, I do it all the time, but at the close of the period you had better have confirmation in the Direction of your assumptions or you say "adios" to the trade. If you do not, you have made a major Mistake. Also, on the subject of Mistakes, you never,

ever, change the reason for a trade. If you entered a trade on the basis of some criteria and that criteria is negated, you don't look around for other criteria to justify your position. If you do, you have made a serious Mistake. Close the trade, and if you have other criteria to be in the trade, re-open it, on that basis. Pay the commission. The long term psychological considerations far outweigh the costs involved. Besides, once you're out of a trade and take a fresh look at it, the reentry criteria may not seem nearly as compelling.

You referred to cupping market action. Is this really the same thing as minimizing whipsaws?

Yes, one of the most common techniques misused by traders is that of tightening up on their stops too quickly. The idea sounds good, but most traders don't have good stop placement techniques in the first place, much less any idea about when to tighten them.

Consider the following daily chart of the Canadian dollar.

From March through the beginning of May, the market is primarily in a strong up Trend as defined by the 3X3. We would therefore be playing the long side, by buying dips, likely on an hourly chart, and selling at specific objectives. These dips and Objective Points are defined by Fibonacci work which will be covered later.

When we reach the top, we have a sustained break through the 3X3 to the downside and the 3X3 contains or "cups" the ensuing rally back toward the top. Look at the expanded view of the top, Chart 4-8.

If we tightened our stops too quickly, after getting short on day A, we would be stopped out on day B or C. If we used the 3X3 as a guide to Trend delineation, we would have no reason to be concerned about our short position, unless we experienced a significant close back above the 3X3. In later chapters, we will cover stop placement techniques thoroughly. For now, what's important is that you understand that the 3X3 is giving the market an opportunity to breathe. The rally back toward the previous top provides a way for those who have provided market liquidity to the sellers, to unwind the long positions they have accumulated, and likely go short themselves.

As you study the concepts defined in this book, you will plainly see that markets are stable and tradable if they have reactions to any significant price Movement. They are unstable and dangerous to trade if there are sustained and violent moves in only one Direction. This is due to the fact that those professionals who have provided liquidity to the markets are the wrong wave!