Apart from aiding in generating buy and sell signals, moving averages can also shed light on future price expansion. In this class of the tech school, we will be looking at what moving average compression (MAC) is and how it helps in trade set ups. In plain English, moving average compression is a concentration of moving averages with different parameters. When it take place on a price chart, the moving averages appears knotted together.
In chart 1of Allahabad Bank, we can view three different simple moving averages, which are plotted based on Fibonacci numbers namely 13, 21 and 34 days.
The point where these moving averages come together and form one line is referred to as Moving average compression (MAC).
MAC works in identifying trade set ups as it represents periods of market contraction. As the price activity cannot be sustained forever, MAC is mostly a predecessor to price expansion. A trader can initiate a trade in the period when the MAC is perceived in the chart to be ready in position to take advantage of the price break-out when it takes place.
In Chart-1, the three simple moving averages are knotted together and appeared as a single line for a number of trading sessions (enclosed by a circle) in early February. This contraction indicated that the stock price is likely to expand soon.
This is precisely what Allahabad bank did in the later part of February and March. The success of the MAC tool in not dependent on the parameters used. One can use very long period moving averages such as 50, 100 and 200-day simple moving average such as that used in chart-2 (Punjab National Bank).
Chart 3 depicts MAC with 13, 21, 34 and 50 day moving averages.