Ribbon studies and multiple moving averages are becoming more and more popular among trend traders. The basic idea behind the technical indicator is that you are using roughly 12-16 different moving averages on the same exact chart (instead of using just 1 or 2 on your chart).
How Do You Build This Indicator?
Typically ribbon studies consists of approximately eight short-term and eight long-term exponential moving averages. The short-term moving average lengths can vary of course and are more dependent on what time frame you are trading.
The chart that I have here is set up with 16 moving averages varying from a 50 day to a 200 day and everything in between. I think this gives me a more accurate look at the overall trend when using long term moving averages. But some will argue that you should start with the 30 day moving average, I disagree.
Trend analysis enables more effective selection of appropriate trading strategies such as breakout, trend continuation etc. Can be applied to long side and short side trading.
Convergence and Divergence Signals
There are generally 3 different signals that you can analyze with ribbons and multiple moving averages:
1) When your ribbons start to become more parallel and and evenly spaced, you can assume that the current trend is strong and in “agreement” with the other signals since they are moving together as a collective.
2) When the ribbons start widening out and separating, this signals that we are starting to reach market extremes and could be the end of trend. Short term MA’s are reaching extremes and the law of probabilities suggest these levels won’t last much longer.
3) And finally, when the ribbons start to converge on each other, a trend change has already begun to occur. An early indicator after seeing extreme levels is that the shorter term MA’s will converge first while the longer term MA’s will slowly converge.
Spacing Is More Important Than Crossovers
Most people incorrectly assume that the only important factor when using ribbon studies and multiple moving averages is the “crossover” or the “twist” in the charts. The point at which the shorter term MA’s start to move above or below the longer term MA’s – and while this is important it’s not the best use of this indicator.
The actual spacing of the ribbons and MA’s really show the underlying strength of the trend. Use the 3 difference spacing points I outlined above and you’ll be well on your way to better trend analysis.
Have You Had Success With Ribbons?
Like I said before, this technical indicator is becoming more and more popular. But I would like to know what kind of success or failure you’ve had with these ribbons for identifying trends? Add your comments below and share any tips or tricks you have found with others.
Watch The 1st Video In This Free 4-Part Series On Options Trading
I've been told by tons of people that you've got to either have a lot of money or a really killer system to trade options and win. Some new indicator or signal that will transform your portfolio.
Honestly, there is no "magic secret" to trading options. It simply comes down to an understanding of risk management, option pricing and strategy selection.
Instead of learning these lessons the hard way (i.e. losing your shirt in the market), why not take my free 4-part video course as I cover each area in detail. Plus, I'll go over the exact checklist I use for selecting trades each month!