In this post, we are going to tell you about What is the best use of moving averages?, Using Moving Average Theoretically, when we talk about price action Trading, we don’t use Technical indicators and We base our Trading decision entirely on the price behavior of the security. But in reality, shall advise Traders to use Moving Average along with price and volume to get a better picture.
What is the best use of moving averages?
Moving average is a simple technical analysis tool that smooths out price data by creating a constantly updated average price. The average is taken over a specific period of time which can be in minutes, days, weeks or months depending on the choice of the trader.
Moving averages do not predict the price direction but rather they define the prevailing direction. It is a trend based indicator that is used to determine the direction of the trend.
A moving average helps cut down the amount of “noise” on a price chart. Look at the direction of moving average to get a basic idea about which way the price is moving.
Types of Moving Averages –
There are two types of moving averages – Simple and Exponential.
Simple Moving Average – A simple moving average is an arithmetic moving average calculated by adding recent prices and then dividing the sum by the number of time periods in the calculation of the average.
Exponential Moving Average – This moving average gives more weightage to the recent data points and hence it is more responsive than simple moving average.
I will not get into the calculation part as I don’t want you to get confused if you are a beginner. You can easily select the required moving average and apply it on any chart on any charting website.
I would not say this is the best or worse time period in case of moving average; rather I will discuss time periods used in moving average by most of the traders across the world and will also explain to you how to use them practically on charts.
You can start using moving average and see what works for you and stick to it as long as it gives you favorable results
1.Uses of Moving Average
Moving average are widely used for determining support and resistance; generate trending signals as well as used for placement or stop Loss.
1.Determining Support and Resistance
A moving average can be used as support or resistance.
In an uptrend, a 50-day, 100-day, or 200-day moving average may act as a support level, as shown in the example below.
During an uptrend you can take long positions whenever a security takes support at an important moving average .
2. 50 DMA S&P
3. 100 DMA S&P
4. 200 DMA S&P
in a Downward, a 50-day, 100-day or 200-day moving average may act a resistance level,as shown in the examples ahead.
During a Downward you can take shot positions whenever a security faces resistance at an important moving average.
5. 50 DMA S&P Resistance
6. 100 DMA S&P Resistance
7. 200 DMA S&P Resistance
- Generate Trading signals
- A moving average can also be used to generate Trading signals popular trading signals generate strategies based on moving average include Golden Crossover and Death Crossover
8. Golden Crossover –
it is bullish crossover strategy that makes use of two moving average and generate a signal for taking long position. It signals for major upside rally.
Golden Crossover appears on the chart when a short term moving average rises above the long term moving average.
The bullish crossover strategy works well when it is accompanied by a spurt in volume when the crossover happens.
it is the most widely used crossover strategy across the globe. The moving average which are used in golden crossover are 50 and 200 day moving average.
Example : Golden Crossover
the image blow show the daily chart of HCL technology from June 2020 to January 2021 showing an example of Golden crossover. after the golden crossover on 7th July 2020, you can see a clear uptrend emerged on the chat.
9. Death Crossover –
it is a bearish crossover strategy that use of two moving average and generates a signal for taking short position. it signals for major downside rally.
death crossover appears on the chat when a short term moving average falls below the long term moving average. This bearish crossover strategy works well when it is accompanied by a spurt in volume when the crossover happens.
it is the most widely used crossover strategy across the globe. The moving average which are used in death crossover are 50 and 200 day moving average.
Example : Death Crossover
10. Placement of Stop Loss or Trailing Stop Loss
Moving average can also be used as stop Loss or Trailing Stop Loss
I have discussed about it ahead in chapter dedicated to stop loss and trailing stop Loss respectively.
Important Note : Don’t use Moving Average in isolation. Always first look at the price action followed by volume analysis and then make use for moving average to get additional input or confirmation..