Trading With Moving Averages provides some very real and very important information to the technical trader.  Moving averages can help a trader identify the price trend of a security but it is important to note that moving averages do not indicate future movement.

There Are Two Common Types of Moving Averages Traders Use:

1.      Simple Moving Average

The simple moving average is calculating by adding up the closing price over a certain period and then dividing that total by the number of periods used.

Example:   To calculate the 30 day moving average you would add up the closing price of the last 30 days of a security and then divide that total by 30.  Each day moving forward you would drop off the 31st day and add the most current closing price and divide by 30.

2.      Exponential Moving Average

The exponential moving average is more complicated to calculate than the simple moving average but all you need to know is that this average puts more weight into the most recent price action.  So, the exponential moving average tends to be more responsive to recent price movement.

Now that you know what these averages are and an idea of how they are calculating it’s time to understand how they can be applied in Technical Analysis.

30 Day Simple Moving Average

The first thing that a moving average can do is help you see the trend of the security you are looking at.  A 30 Day Simple Moving Average is a great way to see whether a stock is trending up, down, or is currently not trending at all.  This is as simple as applying a 30 day moving average to the chart you are viewing as seeing whether that line is heading higher, lower, or is what analysts call “whipsawing” up and down.

Green Line Represents 30 Day Moving Average

As shown above the 30 Day Simple Moving Average is a good start when identifying the trend of stock, option, or security.  It is also very important to understand that moving averages can serve as support and/or resistance to price movements.  This technique is only applicable to markets that are trending.  That is to say that the price action is either trending higher or lower.  When price action is not trending these moving averages lose their significance.

We touched on the 30 days moving average to help us determine if price is trending now let’s take a look at some other very important moving averages and how they can help us as technical traders.

20 Day Simple Moving Average

This is obviously shorter than the 30 day average so this moving average tends to give quicker signals.  Big institutions tend to use this average as support or resistance if they are “Hot” on a stock.  This is to say that in a strong up trending stock institutions may decide to buy when price comes down to the 20 days moving average or vice versa a stock is down trending they may sell when price move up to the 20 day moving average.  So, if you are trading a strong trending stock it would be appropriate to put up a 20 day simple moving average and see if price is finding support or resistance at this average.

Purple Line Represents A 20 Day Moving Average

50 Day Simple Moving Average

This average is used to identify intermediate term trends (weeks to months).  So, if your trading the intermediate timeline this average will provide some strong levels of support or resistance to assist you with the decision making in that trade.

Blue Line Represents A 50 Day Moving Average

200 Day Simple Moving Average

This is a very important average to use as a technical trader.  You won’t need to look at it often but it is a wealth of information to leave on your chart.  Stock prices don’t cross their 200 moving averages often but when they do it is almost always a significant technical signal.  The 200 day moving average is used in the technical trading world as a sentiment indicator.  When something crosses below this average it is a very bearish sign and when price crosses above this average it is a bullish sign.  The 200 day moving average in my opinion acts as the strongest level of support and resistance.

Rep Line Represents 200 Day Moving Average

Trading with moving averages and using moving average analysis is a fundamental tool that any trader skilled in Technical Analysis uses to make sure they catch a ride on the prevailing trend and by doing so swim with the stream, not against it.