Do you use moving average forecasting to help plan your trades? The 50 sma, 100 sma, and 200 are the most popular simple moving average lines, and the nine ema, 13 ema, and 20 are the most popular exponential moving average lines. When the price is near these levels, it shows very important support and resistance levels. Pay close attention to crossovers as well. Technical analysis can be a great tool to help you find the best entries, exits, stop losses, support, and resistance.
Moving average forecasting can be useful for long-term trades. The two types of moving averages most commonly used in swing trading and intraday trading are Simple Moving Averages (SMA) and Exponential Moving Averages (EMA). These two types of moving averages may appear similar on the chart. However, their characteristics are developed from different mathematical formulas with different results.
Every day, someone will ask a question about moving averages, stop loss, profit target, or support and resistance lines in the Bullish Bears day trade chat room.
I wanted to take this opportunity to answer those questions more fully. Before we get into the charts, let’s take a minute to understand the math formula behind the moving averages fully.
Moving average forecasting is used in all types of trade strategies. As a result, moving averages find support and resistance levels and calculate a stop percentage. They can even find a profit target during an intraday scalp, hold, and swing trade.
Hence, proper use of moving averages can protect the trader’s portfolio by perhaps staying out of a trade. You can even protect profits by remaining in a trade until a more profitable exit is shown.
Basics of Moving Average Forecasting
Let’s take a look at how we can use the simple moving average in moving average forecasting. In the formula for an SMA, the oldest candle of data drops away, and the newest candle of data takes its place.
For example, in a 5 SMA formula using a daily chart with Daily Closing Prices (candles) of $111, $112, $113, $114, $115, $116, and $117, we can calculate the formula:
5-day SMA: (3rd day 113 + 4th day 114 + 5th day 115 + 6th day 116 + 7th day 117) / 5 = 115
These final numbers (113, 114, and 115) form the line that develops the SMA across the chart. It presents a picture of the ‘simple price average’ (or a picture of the common price) of the ticker symbol.
The five-day ‘average’ is also the calculated middle number in this example. The lower numbers cause this moving average to ‘lag’ and find the middle (or the mean or the ‘average’).
The 5 SMA study answers this question: over the last five days (or the last five candles), what was the average price of this ticker? The SMA is also called the average, the rolling average, and the moving mean. How can you use that in moving average forecasting?
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Moving Average Forecasting Lags
Notice that the moving average lags behind the price in this equation. On day 5, with a price of $115, the moving average is $113. On day 6, the price was $116, and the moving average was $114.
Again, on day 7, the price is $117, and the moving average is $115. This lag happens because the price needed to produce the moving average has already happened.
This indicator looks back at previous price actions to calculate the moving average. This is also a lagging indicator because it takes these numbers and seeks to find the middle.
Thus, the price was further back than the current price action. Even as a ‘lagging average,” the SMA is one of the most valued indicators in the trader’s toolbox.
EMA Moving Average Forecasting
Let’s look at how we can use the EMA for moving average forecasting. With an understanding that the Simple Moving Average lags, the Exponential Moving Average was developed as an extension of the SMA to reduce this lag.
The EMA is calculated from the whole of the previous price action. This is the first reason the EMA is better suited for a smaller time frame, such as an intraday chart.
Since the EMA must begin somewhere, the Simple Moving Average is calculated first. Then, weights are applied to give the prices closer to the current price more consideration.
The EMA weight is calculated based on the length of the EMA chosen. The formula for a 10-day EMA would look like this:
10 SMA: 10-bar total / 10
Multiplier: (2 / (10 + 1) ) = 0.1818 (18.18%)
EMA: Close – EMA(previous bar) x multiplier + EMA(previous bar)
As you see in this example, the EMA uses the ‘previous bar’ to begin its calculations, so the SMA is calculated first and used as the ‘previous bar.’ This formula is then applied to each bar between the start of the EMA and the current bar.
Just as the SMA had a weakness by lagging and focusing on the middle of all bars calculated, the EMA had a weakness due to the weight applied to each bar.
An EMA with a long length will lose weight as the calculation is applied. The 10 EMAs above weigh 18.8%, but an EMA of 20 only weighs 9.52%.
Each time the EMA length is doubled, the weight drops by half. This is the second reason the EMA is better suited for a smaller time frame (such as an intraday chart)—something to consider when moving average forecasting.
A typical setup for an intraday chart would be using the SMA as the longer-length moving average (to identify support and resistance) and the EMA as the shorter-length moving average (to identify trend reversal and trade signals).
Moving average forecasting can help you determine many important aspects of trading. The charts demonstrate how the moving averages can offer a trader’s perspective on the potential price action before taking a trade.
Knowing where strong support or resistance is before entering a trade can offer the trader perspective on stopping loss, target entry/exit, or avoiding taking a trade. Traders can protect their portfolios or profits by observing how price respects these levels.