Jan 242014
 

The moving average fake-out trading setup was introduced by Mark Fisher. This trade setup is called the moving average fake-out as it uses moving averages to find false counter-trend moves. As Mark Fisher mentioned in his book, you may use the rules to establish a position or a trading bias.

Pivot point/Typical Price = (High+Low+Close)/3

RULES FOR LONG FAKE-OUT

  1. All three SMAs of pivot point sloping up (14-period, 30-period, 50-period)
  2. Pullback down to 14-period SMA without crossing below 30-period SMA
  3. Enter long when prices rise above the lowest prior high above the 14-period SMA

RULES FOR SHORT FAKE-OUT

  1. All three SMAs of pivot point sloping down (14-period, 30-period, 50-period)
  2. Pullback up to 14-period SMA without crossing above 30-period SMA
  3. Enter short when prices fall below the highest prior low below 14-period SMA

WINNING TRADE – MOVING AVERAGE FAKE-OUT TRADING SETUP

Moving Average Fake-Out Winning Trade

Moving Average Fake-Out Winning Trade

This is a daily chart of AON Corporation listed on NYSE. All three moving averages were sloping up (color change from red to green). Prices continued to rise above the moving averages. This was followed by a sideways movement to the 14-period moving average, giving us the moving average fake-out setup. We placed a buy stop order above the high of the first bar that tested the 14-period moving average. The order was triggered the next day and led us into an extended bull trend.

The trade setup bar that tested the 14-period moving average had a long bottom tail. It is a sign of bullish support after the moving average fake-out. The next day was a bullish outside barwhich confirmed the support found at the moving average.

LOSING TRADE – MOVING AVERAGE FAKE-OUT TRADING SETUP

Moving Average Fake-Out Losing Trade

Moving Average Fake-Out Losing Trade

This is a daily chart of Korea Composite Stock Price Index (KOSPI) which tracks all the stocks listed on the Stock Market Division of the Korea Exchange. The three moving averages sloped up to confirm the bullish price action. Then, we saw a pullback down to the 14-period moving average. Prices tangled with it for two days before gapping up to trigger the buy order (at the blue horizontal line). The trade moved against us immediately. A few days later, a strong gap down forced us to exit with a loss.

This moving average fake-out setup was a reasonable one. The first bar that tested the 14-period moving average was a bullish reversal bar. It was followed by a bearish inside bar which was the second attempt to push prices down. These were bullish signs.

However, the climatic bullish action before the pullback might have been a concern. Climaxes tend to lead to either reversal or sluggish movement. Each of the three bars following our entry gapped up before closing down, which was extremely bearish. Hence, we had more than enough warning to get out before the large gap down (which changed the slope of the 14-period moving average down).

REVIEW – MOVING AVERAGE FAKE-OUT TRADING SETUP

The moving average fake-out trading setup is a trend pullback trade setup. The use of multiple moving averages is usually redundant. Fortunately, this trade setup uses only three moving averages which is about the most my brain can process. In addition, the periods 14, 30 and 50 are all intermediate periods that are relatively meaningful.

A short period is just a proxy of price itself and only serves to confuse price action; a long period lags as a trend indicator and does nothing to filter ranging conditions. By focusing on the slope of these three intermediate period moving averages, Mark Fisher created a nice package of multiple moving averages. Look at the KOSPI chart above beyond the losing trade and you will see that this trading setup kept us out of ranging price conditions. Slope of moving averages hardly agree for any trade to take place.

A key feature of Mark Fisher’s moving average fake-out setup is the use of pivot points instead of closes for the moving averages. Using pivot points does not make much difference except for some smoothing. In fact, the closing price of each day holds important information as it is the price that all players contributed to by the end of each trading session. However, for intra-day charts, especially for non-time-based charts including tick and volume charts, that have their bar closes determined arbitrarily, using pivot points may make more sense.

The moving average fake-out trading setup is also a tool to determine a trend bias. Mark Fisher suggested this approach to augment other methods mentioned in his book,  ”The Logical Trader“.

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