There are a number of common moving averages. They all have their pros and cons.
First, lets take a look at what moving averages are and do. Moving averages take
the averaging of a stock’s price over a certain period that you define. What this
does is smoothes out the data so you can tell “on average” if the stock is going
upward or downward. After all, that’s the name of the game. So a moving average
is good about answering the question of “what direction to trade”. (However, you’ll
find that the MACD answers the questions of “when to trade”.) So when you combine
the two, they can be powerful. Moving averages are mainly good in trends and do
little good in ranges. So now the question is which moving average periods are best.
The most commonly used moving averages are 10, 20, 50 and 200 day Simple Moving
Averages. It’s important to know that there are other types of moving averages out
there that aren’t quite as widely used such as Exponential Moving Averages (EMA’s)
and Weighted Moving Averages (WMA’s). However, most big institutions use the simple
moving average. A simple moving average weights all the data the same while an exponential
or weighted moving average places more emphasis on the latest data (towards the
right of the chart) rather than the older data (towards the left half of the chart).
So a simple moving average of 10 periods is going to give us the average price of
that stock over the last 10 days. With each new day, it adds in that day to the
data and drops off the oldest day to calculate the new average. The moving average
is a smoothed line that connects all of these averaging points together into the
moving average line.
A 10 or 20 period moving average is going to change quicker with the price action
and hug closer to the price action. The pro is that it’s quick in responding to
price movements. Its con is that while it does somewhat act as support/resistance;
it’s a weaker one than a longer term moving average. A longer term moving average
such as the 50 or 200 day simple moving average will respond slower to the price
action (con) but offers stronger areas/regions of support/resistance in and of themselves
than do the shorter moving averages (pro).
Let’s take a look at some below and see what they look like on the chart. Below
we see a (20 day SMA) distinct downtrend on the left side of the chart and then
it switches into an uptrend later on in the chart. In the final 2-3 months of the
chart, the QQQQ’s go into a sideways range. This is where the moving averages would
do little good except show that it’s in a range. Note that when the QQQQ’s are distinctly
trending downward, the moving average provides an area of resistance. When the QQQQ’s
are in an uptrend, the moving average acts as a general area of support for the
price. When it goes into a range, it doesn’t act as either support or resistance.
Moving Averages are used to smooth the data in an array to help eliminate noise
and identify trends. The Simple Moving Average is literally the simplest form of
a moving average. Each output value is the average of the previous n values. In
a Simple Moving Average, each value in the time period carries equal weight, and
values outside of the time period are not included in the average. This makes it
less responsive to recent changes in the data, which can be useful for filtering
out those changes.
See also Exponential MA, Least Squares MA, Triangular MA, Weighted MA, Welles MA,
Variable MA, Volume Adjusted MA, Zero Lag Exponential MA, DEMA, TEMA and T3.
Now that we’ve taken a look at a shorter term moving average, let’s now look at
a longer term moving average, the 200 SMA.
This average points to the long term trend direction and shows where many of the
long term investors may be holding the stock. It’s averaging the last 200 days of
data. Notice how it can act as regions of support in an uptrend or regions/areas
of resistance in a downtrend.
To recap: The best technical indicators are firstly trend lines/support/resistance/volume.
After that would come the versatility of the MACD. It can be left on the chart at
all times. Use only buy signals in the uptrend and sell signals in the downtrend.
Use both signals in a range.
In Trends use 2-3 of the following maximum:
1. Trend lines
2. Moving Averages
3. MACD (buys in uptrend or sells in downtrend)
4. ADX (above 30)
5. PSAR (for stops in strong trends) OR
6. ATR levels for stops
In Ranges, use 2-3 of the following maximum:
2. MACD – both buy and sell signals
3. Bollinger Bands
5. Slow Stochastics
6. ADX below 30
7. ATR levels for stops