How we use moving averages to trade

How we use moving averages to trade

At Income Switch we use moving averages on every time frame of our charts.  Our main MA (moving average) studies we use are the 15 day exponential moving average (EMA) and 50 day simple moving average (SMA) with the 20 day Hull Moving Average (HMA) as a background.  Most “on the floor” use the 63 day moving average for confirmations (above bullish, below bearish).  My overall goal as a successful trader is to make trading as simple as possible and have found the 15/50 to be fairly accurate for shorter term moves.   It doesn’t mean that the stock is going to make a big move fast, but it typically stands as a nice support for the underlying stock.    

I also use the 15/50 on the 30min chart for quick intraday moves.  These usually continue moving for a day or two, in fact UAL just paid us over 100% on this exact movement last week.  

I personally use this exact study with a few others including TTM Squeeze, DXI/ADX, and a modified version of the Darvash Box I had specifically made based on volume, price action and a few other factors.  I get an alert on ToS whenever all of my indicators trigger a buy.  I sometimes get junk that I still have to sift through, but it gives a great base on where to start looking.  

I got a buy alert on BOOT last Thursday.  You can see here:


The Blue Line is the 15 day EMA, the Red Line is the 50 day SMA and the purple/green is a 20 day HMA.  You can see all of the entry and exits over the last year and how the stock played out after that (thanks to our member, NSonik for creating that)

Can you play every ticker off of these moving averages?  Possibly, typically it will start an uptrend or downtrend but we usually will wait for confirmation elsewhere to make sure.


What is a moving average?

The moving average (MA) 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, like 10 days, 20 minutes, 30 weeks or any time period the trader chooses. There are advantages to using a moving average in your trading, as well as options on what type of moving average to use. Moving average strategies are also popular and can be tailored to any time frame, suiting both long-term investors and short-term traders.

Why Use a Moving Average

A moving average helps cut down the amount of "noise" on a price chart. Look at the direction of the moving average to get a basic idea of which way the price is moving. If it is angled up, the price is moving up (or was recently) overall; angled down, and the price is moving down overall; moving sideways, and the price is likely in a range.

A moving average can also act 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 figure below. This is because the average acts like a floor (support), so the price bounces up off of it. In a downtrend, a moving average may act as resistance; like a ceiling, the price hits the level and then starts to drop again.

A moving average can be calculated in different ways. A five-day simple moving average (SMA) adds up the five most recent daily closing prices and divides it by five to create a new average each day. Each average is connected to the next, creating the singular flowing line.

Another popular type of moving average is the exponential moving average (EMA). The calculation is more complex, as it applies more weighting to the most recent prices. If you plot a 50-day SMA and a 50-day EMA on the same chart, you'll notice that the EMA reacts more quickly to price changes than the SMA does, due to the additional weighting on recent price data.

One type of MA isn't better than another. An EMA may work better in a stock or financial market for a time, and at other times, an SMA may work better. The time frame chosen for a moving average will also play a significant role in how effective it is (regardless of type).

Moving Average Length

Common moving average lengths are 10, 20, 50, 100 and 200. These lengths can be applied to any chart time frame (one minute, daily, weekly, etc.), depending on the trader's time horizon.

The time frame or length you choose for a moving average, also called the "look back period," can play a big role in how effective it is. 

An MA with a short time frame will react much quicker to price changes than an MA with a long look back period. In the figure below, the 20-day moving average more closely tracks the actual price than the 100-day moving average does.

The 20-day may be of analytical benefit to a shorter-term trader since it follows the price more closely and therefore produces less "lag" than the longer-term moving average. A 100-day MA may be more beneficial to a longer-term trader.

Lag is the time it takes for a moving average to signal a potential reversal. Recall that, as a general guideline, when the price is above a moving average, the trend is considered up. So when the price drops below that moving average, it signals a potential reversal based on that MA. A 20-day moving average will provide many more "reversal" signals than a 100-day moving average. 

A moving average can be any length: 15, 28, 89, etc. Adjusting the moving average so it provides more accurate signals on historical data may help create better future signals.