Using moving averages to manage risk is a favorite strategy of traders. It is, of course, as much of an art as it is a science, Bloomberg’s Richard Breslow writes.
When you find a truly useful moving average it can be the gift that keeps on giving. Using moving averages on longer time segments like months can be tough for most traders given the swings in price that have to be endured looking for confirmation of a move. I only use closing prices not intra-period spikes. But a good longer period moving average can give an indication of what could be the bigger picture bias (trend) to an assets price.
Get the general trend right and it can act as a get out of jail free card for trades that may not look good in the short-run.
It can also provide insight in what may be going on or going to be going on in other correlated assets. Yesterday, month end August, the SPX closed below its 21-month moving average. Only once in the last 20 years has a close that crossed back through this moving average not resulted in a multiple month stay on the new side; see the chart here (тhe only “false” signal was in September 2011, when the S&P closed below this line and closed back above the next month. This was a period when, ironically, S&P cut the Unites States’ credit rating (August) with outlook negative). The operative assumption at the time among traders was this would lead to a spike in borrowing costs. The implications of the Fed’s announcement of Operation Twist (September) was initially misunderstood and the market was hit with a “risk off” move and a stronger USD. This was short-lived with the SPX rocketing higher after an October 4 low.
If this does prove to be a meaningful event (my hedge and disclaimer) it could also have spill over to the USD, make the stubbornly low 10-year yield in Treasuries more understandable and make the bounce we have seen in commodities more believable.
This past weekend, Fed Vice-Chair Fischer used the term “rational expectations” in declining to provide specificity on what the FOMC might conclude at the September meeting. It is very possible that the market is indeed expressing its rational expectations of the event with this move.
* NOTE: Richard Breslow, is a former FX trader and fund manager who writes for Bloomberg. The observations he makes are his own
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