Moving Averages - Basics

Moving Averages Techniques

“Emotions are your worst enemy in the stock market.”

Moving averages provide important information regarding the direction of a market. They were created to provide directional information, smoothing out the zigs and zags of a trend. Their use has become much more predominant with the advance of computer software. The automatic calculations for MAs (moving averages) have greatly simplified their applications. They can now be calculated and utilized up to the very second/minute in a trading chart. Their applications, along with candlestick signals, provide a very strong profitable trading format. As with all other technical indicators, MAs have a relevance when correlated to price movement. How the moving averages are utilized can make a big difference between moderate returns and highly profitable returns.

Trading techniques, using moving averages, provide improved entry and exit strategies. The most common use is when the relevant moving averages cross. The feasibility of using MAs “crossing” apparently has some relevance or it would not be widely known as one of their useful aspects. However, the benefits of moving averages become greatly diminished if “crossings” are the only application used. The accuracy of the crossing analysis is moderately suc­cessful. However, there are many technical evaluations that are moderately successful. Applying Candlestick analysis in relation to the MAs provides a higher function.

Candlestick signals, along with the moving averages, create a trading pro­gram that produces highly profitable trades. Using the important moving aver­ages as support and resistance areas, in conjunction with candlestick analysis, advances the probabilities of participating in a correct trade. Trades are pro­duced with a much greater frequency. The point of investing is to find addi­tional processes for using technical indicators that provide a very high ratio of successful trades. Fortunately, the use of moving averages is very simple. Once applied to candlestick charts, it makes the trend analysis, of probable support or resistance, a very simple, visual process.

The question always arises whether to use the simple moving average (SMA), the exponential moving average (EMA), or the weighted moving aver­age (WMA). The simple moving average is the easiest to calculate; therefore, the reason it was well used before the presence of computers. The exponential moving average has become more popular in recent years due to the quicker calculation’s computer software provides. It incorporates the latest data in its calculations, allows the older data to fade out, making the current data more pertinent. Weighted moving averages put more importance on current data versus older data. Simple moving averages work very well, providing the infor­mation required to successfully trading candlestick signals. Money managers, as well as a majority of technical investors, use the simple moving average.

The moving averages provide a simple visual indicator that shows the direction of a trend’s slope. When the moving averages are rising, it indicates an uptrend. When the moving averages are falling, it indicates a downtrend. If the moving averages are trading sideways, it reveals a sideways market.

Traders that use the moving average method for indicating trends follow some very basic rules.

1.  If the SMA is trending up, trade the market on the long side. Buy when prices pullback to, or slightly below, the moving average. After a long position is established, use the recent low as your stop.

2.  If the SMA is trending down, trade the market to the short side. Short (sell) when prices rally to or slightly above, the SMA. Once a short position is established use the recent high as your stop.

3.  When the SMA is trading flat or oscillating sideways, it illustrates a sideways market. Most traders, utilizing the moving average to deter­mine trends, will not trade in this market.

Simply stated, traders that use the SMA as a trend go long (buy) when prices are trending above the moving average. They will go short (sell) when prices are trending below the moving average. The candlestick trader has an im­mense advantage of being able to see what the candlestick signals are telling them at these important moving average levels.

There are numerous timeframes that appear to have relevance when us­ing the moving averages. The 3, 5, 10, 15, 20, 30, 50, 80, 100, 200, 400, 500, 1000 moving averages are all used. Through extensive studies, theforex7, it has been revealed that the 50-day moving average and the 200-day moving average are the most important moving aver­ages. There seems to be a great tendency for prices to support or resist at those averages. Therefore, the 50-day and 200-day moving averages are considered major moving averages. The 20-day and the 80-day moving average are also important but should be considered secondary moving averages. Are there other moving averages that work effectively? Probably, but the major and sec­ondary MAs discussed here seem to have a statistical relevance.

Technical indicators provide important information. An indicator gains importance because of the reoccurring significance of major investment con­siderations happening at those points. This explanation is put forth so that each investor can become convinced, in their own minds, that moving averages, especially the ones being recommended in this chapter, have some relevance. The major moving averages act like magnets. They attract the price from one moving average to the next moving average.

Through the following chart evaluations and one’s own chart studying, the relevance of these moving averages should become apparent. This does not an investor from constantly being aware that other moving averages may start gaining importance in the eyes of other technical investors. The point of using these moving averages, along with candlestick signals, is that historically many investors are watching to see what price movements do at these levels. The advantage of the candlestick signals is that the signals tell you exactly what investors are doing at those levels.