How to Use Moving Average in Trading
June 09, 2021
How to Use Moving Average in Trading
Moving Average (MA) is a calculation where multiple averages are created using data subsets of a whole data set to identify and analyse trends. In the stock market, it is used as a technical indicator to plot future stock price trends. The most common moving averages are the 15-, 20-, 30-, 50-, 100-, and the 200-day moving average.
There are many other technical indicators, such as the relative strength index, stochastic oscillator, and pivot points. This article will focus on the moving average indicator, how to use the moving average method to trade, and moving average strategies. It will also cover a related indicator called the moving average convergence divergence (MACD).
Types of Moving Average
To start off, there are two main types of moving averages, the simple moving average (SMA) and the exponential moving average (EMA).
The SMA is calculated by taking the closing prices of a security for the relevant period, adding them, and then dividing the sum by the period number.
The EMA is more complex than the SMA. In the latter, each price in the MA is given equal weightage. The EMA uses a more complex calculation as it gives more weightage to the most recent prices.
Using Moving Average
The moving average is a lagging indicator, i.e., it provides data on past prices. The longer the moving average time period, the greater the lag. A 200-day MA (DMA) will lag much more than a 20-DMA since the former is plotted for the past 200 days. The latter will lag much less since it is plotted using the most recent 20-day data.
The moving average is a completely customizable indicator. You can opt for a moving average of any period length. The shorter the MA, the more sensitive it is to price changes.
Here are a few pointers on using the moving average:
Traders use short-period moving averages and longer-period ones as well.
You have to experiment with multiple time periods of the moving average before deciding what works best for you.
A rising moving average indicates a security price trending upwards; a downward moving average, the opposite.
Using Moving Average to Spot Trending Direction
When a stock is on an uptrend, its moving average will act as the support (the floor) price.
In a downtrend, the moving average will form a resistance (ceiling) level, with the stock price likely to go downward.
Moving Average Convergence Divergence
You can also plot two or more MAs for a stock simultaneously to detect crossover, i.e., the point at which one MA intersects the other.
This brings us to the moving average convergence divergence (MACD). The MACD is the difference between a stock’s two EMAs – the 12-period and 26-period EMAs. The result is plotted as the MACD line.
Next comes the MACD signal line – a nine-period EMA of the MACD value. When plotted over the MACD line, it acts as a trigger to buy or sell. It is a buy signal when the MACD crosses above the signal line; it is a sell signal when it crosses below the signal line.
Crossover Trading Strategies
Here are some key crossovers trading strategies:
When the price of a stock crosses over above or below the MA, it signals a change in the stock’s price trend.
Two plotted MAs are bound to crossover at various points. The point where the short-term MA crosses above the longer-term MA is a buy signal, signifying a bullish pattern. When the shorter-term MA crosses below the longer-term MA, it’s a sell signal, indicating a bearish pattern.
200-day moving average strategy: You plot the 200-day price line and its 200-day MA. If the stock price is above the 200-day MA, it is a buy indicator. If it is below the MA, it’s a sell.