Technical Analysis

Moving Averages | Beginners Guide

Moving Average (MA) is by far the most used trend measuring indicator by traders.  

There are two types of moving averages: 

  1. Simple Moving Average (SMA)
  2. Exponential Moving Average (EMA)

The only difference between the two is that SMA moves a little slower than EMA. Reason for this is that SMA is calculated on the basis of price data average while the EMA gives more weight to the current data. 

Which one is more useful ?

Entry:

This totally depends on your trading style. If you’re a short term trader, EMA is more suited to you as it gives entry points a little faster compared to SMA and you’ll be getting more trades.  

While for a swing trader, SMA is more useful as it gives more confirmed signals. (This is in comparison to EMA). So, the number of trades might be less but profit percentage per trade will be higher. 

Riding the trend: 

As EMA moves faster during price movements, it is more prone to giving false sell signals during little pullbacks. 

While SMA moves slower and this works to its advantage here, prices mostly bounce back off the SMA’s during trends. Another reason for this difference is that more traders use SMA and not EMA.

In short, SMA gives you a higher chance of riding the trend than EMA.

NOTE: The indicator which is widely used will always see more volume on its entry and exit points. Hence, the chances of it being successful is more. 

When not to use Moving Average?

You can’t use moving averages all the time. MA are only supposed to be used in trending markets. As during sideways trading you’ll get more false signals resulting in losing trades. 

For example, see the image below: 

This graph shows false signals given by Moving Averages during a sideways market. Inside that box, we got few crossings but none of that was an entry point. 

It is always recommended to take entries on the 20/21 Day MA and place a stop loss just below it. So, In cases like these, you can get out with a minimal loss. 

What length to use ?

Traders use different MA settings for different purposes. Let me explain you some of the most used lengths. 

  • 8 Day/10 Day: This is the one mostly used by short term traders, to take entries as soon as possible. When this crosses 20/21 Day MA to the upside, it signals a buy opportunity and downwards crossing signals a sell opportunity.
  • 20 Day/21 Day: This one is the most widely used MA, It is used by both short term and medium term traders. When the 20/21 Day MA crosses 50 day MA on the upside it signals an uptrend. Once the trend is in full swing, trades use it as support to rider medium term trends. 
  • 50 Day:  This is more of a long term trend identifier, and the 2nd most popular one after 20/21 Day MA. Traders use this as support for the longer term trend and it is quite a strong support too. Bounce back from here can give traders good profits. 
  • 100 Day: This is another longer term MA used to identify support and resistance levels. Used by most traders when the price is around this MA but once the trend is in full swing, we don’t see it coming into play for quite some time again. 

Now that we know what are moving averages, when to use it, when not to use it and some mostly used lengths. Let me show you some real examples in the charts below: 

You just need to keep two things in mind. 

  1. Whenever both 10 Day and 20 Day MA are below 50 Day MA, wait for both to cross it upwards before taking any long entry. This is shown at point D in the above image. 
  2. When the trend is in full swing, use 20 Day as support and you take entry when 10 Day bounces off 20 Day MA. This is shown at points A, B, C and E.

Let me also show you some examples of short entries taken at the bearish cross. Look at the chart below, points A, B and C all demonstrate short sell signals given by the Moving Average crossovers. 

Key Points to remember while trading on Moving Averages, ALWAYS:

Best entry points to go long: 

  • At the crossover of 10, 20 day MA and 50 Day MA on the upside. 
  • At the support retest of 50 Day and 100 day MA. 

Best entry points to go short:

  • At the crossover of 10, 20 Day MA and 50 Day MA on the downside. 
  • Failure to reclaim 50 day and 100 day MA as support and price goes down again. This shows strength of sellers and confirms the long term moving average as resistance. 

I hope you found what you were looking for in this post, If you’ve any other query, you can let me know in the comment section below.

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