What are moving averages?

A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random short-term price fluctuations. It is a trend-following, or lagging, indicator because it is based on past prices.

https://www.investopedia.com/terms/m/movingaverage.asp

The two most widely used moving averages are Simple and Exponential.

A simple moving average (SMA) is an arithmetic moving average calculated by adding recent closing prices and then dividing that by the number of time periods in the calculation average. A simple, or arithmetic, moving average that is calculated by adding the closing price of the security for a number of time periods and then dividing this total by that same number of periods. Short-term averages respond quickly to changes in the price of the underlying, while long-term averages are slow to react.

https://www.investopedia.com/terms/s/sma.asp

The exponential moving average (EMA) is a weighted moving average (WMA) that gives more weighting, or importance, to recent price data than the simple moving average (SMA) does. The EMA responds more quickly to recent price changes than the SMA. The formula for calculating the EMA just involves using a multiplier and starting with the SMA.

https://www.investopedia.com/ask/answers/122314/what-exponential-moving-average-ema-formula-and-how-ema-calculated.asp

Now that we understand what moving averages are lets talk about what ones we should be using.

I am a firm believer in keeping it simple stupid. There are zero reasons to have a million indicators on your charts because a wise man once told me all indicators are probably right its how you use them that matters. Blindly staring at 20 indicators is not only going to confuse you but do you really feel other traders are looking at the same indicators you are? If we are trading momentum stocks we want to see what the algorithms, institutional traders and other retail traders are seeing. For example if every one else is watching the 200sma for resistance and you’re watching the 152ema you might go short too soon. Keeping it simple means not over thinking it trying to create a crazy strategy based on random indicators that no one in their right mind would use.

So what moving averages do most momentum traders use?

When looking for support and resistance based on moving averages it is best to use the 100 and 200sma on the daily charts. These are highly respected on mid/large cap stocks where there is a lot of algorithmic and institutional trading.

Notice how the $SPY respected the 100sma (daily transposed onto an intraday chart) on 2/1/19

What about intraday moving averages?

When using moving averages intraday they can provide confirmation of price direction and patterns. Popular ones are the 9ema and 20ema.

Notice how well the 20ema provides an entry signal and exit signal on this 15 minute chart of $AMD on 1/31/19 Capturing almost 2 whole points of profit.

When trading patterns, moving averages can confirm breakouts on multiple time frames. My favorite pattern, the Bull Flag, is seen over and over across the market. When two time frames can confirm the pattern it only makes it that much stronger. When a pattern is easy to see other traders will likely be in alignment with the overall direction of the price.

$TMSR on 2/1/19 using the 9ema on the 5 minute and the 20ema on the 1 minute chart clearly identifies a bull flag pattern. On the one minute chart the pattern doesn’t break out until the the pull back reaches the 9ema on the 5 minute chart. Using two time frames and their respected moving averages can help confirm chart patterns. And remember if they are easy to see other traders will probably be trading them to!

Post Author: straderadmin