How to Use Moving Averages to Trade Trends

How to Use Moving Averages

They are looking for how to use moving average lines to trade trends. MA lines show very popular support and resistance levels when trading. The trend is typically bullish when price action is above moving average lines. If the price is below moving average lines, then it’s typically bearish. This isn’t always the case, especially in consolidation areas. They are lagging indicators and aren’t foolproof, but they can be very helpful guides for determining entries and exits. Watch our video on how to use moving averages to trade trends.

Do you know how to use moving averages to trade trends? Moving averages are important because they give traders an understanding of the state of the market. Whether intraday, swing, or long-term investing, using and understanding MAs will give you a leg over the competition regardless of your trading type. In their simplest form, moving averages (MA) are just lines calculated using past prices to confirm or identify a trend. 

Many traders use moving averages to trade trends because it usually does not require a speedy decision-making process and execution. More often than not, it doesn’t require the use of hotkeys. 

Hotkeys are great for traders who want to get out and trade at light lighting. However, you’ve had great stock training if you know how to use moving averages to trade trends.

Introduction

As their name implies, a moving average is an average that moves because of this, old price data dropped as new data became available, causing the average to move along the time scale. 

As a result, they are moving averages smooth price data to form a trend following indicator. What’s important to note is that they lag based on past prices.

Nevertheless, please recognize they don’t predict price direction but rather define it. So, do you know how to use moving averages to trade trends?

Their ability to smooth price action and filter out the noise sets moving averages apart from other indicators. They form the building blocks for many other technical indicators, i.e., Bollinger Bands, MACD, and the McClellan Oscillator. 

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Two Types of Moving Averages

Two of the most popular types of moving averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).

As I mentioned above, they can be used to identify the direction of the trend or define potential support and resistance levels. This is great for stock market trading.

Typically, the best entries occur once a stock has taken off, and it pulls back as bulls take profit. New and patient bulls lie in wait to jump in when the timing is right.

Day traders are hunters of volatility. Getting in on the action can be tempting when a low-float stock rips. No one wants to miss out on a move that shoots up. 

However, chasing a move is a great way to end up with a loss. Hence the need for patience. The market trades in cycles. It would go to show that stocks are the same as well.

Those cycles often occur much more quickly than the market because of profit profit-taking. You’re a day trader and take your profits within the same day. Hence, it is the ability to have patience and wait for the dip buy. Take our swing trading course.

1. Simple Moving Averages

When you know how to use moving averages to trade trends, you can use the SMA. We calculate the average price of a stock over a specific number of periods to obtain the simple moving average.

More specifically, we add up the closing price of a stock over several periods and then divide that figure by the actual number of periods.

For example, a 5-day simple moving average is the five-day sum of a stock’s closing price divided by five. 

The formula to calculate is as follows:

Simple moving average = (P1 + P2 + P3 + P4 + … + Pn) / n

We use moving averages as one of the tools we use to build our stock watch lists.

2. Exponential Moving Averages

Exponential moving averages differ from simple moving averages. A given day’s EMA calculation depends on the EMA calculations for all the days before that day.  

Because of this, EMAs reflect the latest changes in the stock price more than the other moving averages do. Given the fact that EMAs give more weight to the most recent prices, they end up reducing the lag.  

For example, you need more than ten days of data to calculate a reasonably accurate 10-day EMA.

The formula for calculating is as follows:

Exponential moving average = [Close – previous EMA] * (2 / n+1) + previous EMA

Check out our trading service to learn how to use moving averages to trade trends.

How to Use Moving Averages to Trade Trends

Even though there are clear differences between SMA and EMA, one is not necessarily better. Because exponential moving averages have less lag, they are more sensitive to recent prices and price changes.

Another subtle feature of using EMAs is that the chart turns quicker when a price reverses direction. 

On the other hand, simple moving averages represent the true average of prices for the entire period. So, simple moving averages may be a better choice if you want to identify support or resistance levels. 

How to Use Moving Averages

How to Use Moving Averages to Find the Trend

Trading the trend is one of the best ways to make money in the stock market. How can you use moving averages to find the trend? The moving averages will point up when the market or stock is in an uptrend. When in a downtrend, the moving averages will point down.

Ways to Trade Moving Averages

You are identifying the Strength of a Trend. One thing I know to be true in the trading world is this: the farther the price is away from the moving average, the weaker the trend. A weak trend translates into a trading opportunity – a potential reversal is on the horizon. Armed with this information and other indicators like volume, you’re well on your way to executing a winning trade.

They are identifying the Direction of a Trend. The direction of the moving average tells us important information about a stock price. A rising moving average means prices are rising. Likewise, a falling moving average indicates prices, on average, are falling. A rising long-term moving average characterizes a long-term uptrend. Hence, a long-term downtrend is characterized by a falling long-term moving average.

They are identifying Trend Reversals with Crossovers. As I mentioned above, typically, a weak trend means a reversal is coming, and crossovers help to confirm. After an uptrend, for example, if the nine-day MA crosses below the 50-day MA, the bullish trend may be reversing, signaling the start of a bearish trend. Be advised that there tend to be frequent fake-outs with crossovers that catch new traders off guard. You should always confirm reversals using other methods and tools for these reasons.

Identify Entry and Exit Points. Not only are moving averages used to identify trends, but they are powerful buy or sell indicators. One of the simplest strategies utilizes crossing two or more moving averages as an entry/exit trigger. Your basic signal is when the short-term average crosses above or below the longer-term moving average. 

9/20 EMA's

I use the 9 and 20 exponential moving average indicators on my charts. Crossing these lines signifies a shift in price direction; it’s as simple as that. Now, you have the option to use the 13 EMA as well. It all depends on what you’re comfortable with. I’m using the 9/20 EMA crossover to verify my entry and exit points.

I highly suggest having multiple MA lines with differentiating time frames displayed on your chart. I use the 9, 50, and 100-day MA as it gives me a bird’s eye view of the market, which helps me identify stronger trends and possible reversals.

When going long on a stock, I want the candlesticks above the 50 SMA (a simple moving average). Likewise, I want the candlesticks to be below the 50 SMA when I fall short on stock.

Tips I Picked up Along the Way

As you know, or soon will, people are always eager to help out a new trader, which can be nice when learning how to use moving averages to trade trends.

I habitually write down tips I’ve received along the way. I thought I’d share them with you. It’s up to you whether or not you want to follow them, but they may help.

  • Buy stocks when the 15 EMA crosses over/goes above the 50 EMA, which indicates an upward price movement shortly; this is good for frequent short-term trades.
  • Buy stocks when the 50 EMA crosses over/goes above the 200 EMA.
  • The further the stock is away from the 13 EMA, the higher the chance it will snap back.
  • Buy as close as possible to the moving average line.
  • Ride the trend until the break of the moving average.
  •  Trading off MAs usually works best during the mid-day and closing sessions, as it takes time for the trend to play out. At the market open, it’s generally too volatile and hard to identify a moving average trend play. 

Final Thoughts: How to Use Moving Averages

Do you know how to use moving averages to trade trends? Moving averages are powerful trading tools every trader should have in their toolbox.

Their greatest strength is their ability to help a trader identify a trend or spot a possible trend reversal.

They can also define a stock’s level of support or resistance or act as a simple entry or exit signal. 

Choosing to use moving averages is entirely up to you. But all things considered, you’d be wise to incorporate them into your trading strategy.

Check out our free online trading courses for further information on moving averages and how to trade them.

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