Moving Averages

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In this lesson we will show you the most popular indicator for trend analysis and potential reversals. As we saw in the previous lesson, moving averages are trend indicators. We will introduce you to moving averages, show you the different types of moving averages, the timeframe for using moving averages and finally some practical examples. The simple one is nothing more than the average of a series of data. It is calculated by adding the values of the series and and dividing by the number of observations.

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We can find this indicator in most trading platforms. In this example we look at Trading View. Using the candlestick chart, we can select our time window. Like the daily or intraday at 5, 10 or 15 minutes. The candlesticks represent price movements within that window.

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This indicator is calculated on the closing prices of the candles. Within the indicator, we can decide the number of observations or number of candles that will be part of our average. The most used ones are the nine, the 20, the 50 and the 200 moving averages. They are called moving averages because they are recalculated continuously as new data becomes available. Here are the most commonly used types of moving simple moving average or sma.

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This is calculated by adding the closing prices of a stock or any other financial asset for a set number of time periods and then dividing this total by the number of time periods. For example, a 20 day SMA would add up the closing prices for the last 20 days and divide by 20. The SMA gives equal weight to each price point. Weighted moving average or wma. The WMA assigns more weight to recent data points.

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However, the weighting decreases linearly for older prices. Unlike the exponential moving average where the weighting follows an exponential decay. The last type is the exponential moving average or ema. The EMA gives more weight to recent prices which makes it more responsive to new information. Like the simple moving average, it is calculated over a specified number of time periods, but the calculation is more complex incorporating a weighting multiplier to emphasize recent prices.

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Here we can see the formula. Moving averages are defined as unbiased trend indicators. While trend lines are subjective. Moving averages are calculated quantitatively on the chart. They can be used on all time, daily, weekly and monthly and also intraday.

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Moving averages are typically calculated on the closing prices of the candles. Traders don't normally rely on one moving average, but they tend to add more than one to the chart. Like in this example we have the 20, the 50 and the 200 days moving averages. We can then add fast or slower moving averages to our chart and look at crossovers of moving averages to define our entry or exit points. The most Common moving average we use are the the 5 day exponential moving average, the 9 day exponential moving average, the 22 day exponential moving average, the 50 day simple moving average and the 200 day simple moving average.

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Let's look at them in detail. The five day EMA is used as a signal of strong momentum and takes into account the price action in a very low timeframe. The nine day EMA is an excellent indicator that helps us to follow the market trend. A break below this indicator can be considered as a first warning signal on a potential retracement of the current trend. The 22 day EMA is a moving average of an intermediate period.

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It offers a first level of support in a volatile and trending market. We use the 50 day SMA as a signal of support and resistance. As we said previously, the price action is determined by the meeting between supply and demand of the security during pullbacks. This moving average offers a good support point. Many traders use it as a level to buy the dip.

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Lastly, the 200 days SMA. This level is a key point of long term support and resistance. It is perhaps one of the main lines on the chart that helps us identify the direction of the market. When the price breaks this moving average, it is a sign of a potential trend reversal. Note however that moving averages cannot predict the future.

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They help us identify support and resistance points, identify trends and potential reversal points. They help us evaluate the activity of buyers and sellers and supply and demand. Before moving on to practice, we want to clarify some fundamental concepts to understand how to use moving averages to our advantage. We speak of momentum when we are at the beginning of a strong upward or downward movement or a breakout of support and resistance levels. Momentum is based on the idea that a security can reach increasing highs and lows and the achievement of a new trading range.

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A momentum trade is usually a short term way of trading a few days or weeks. Trend trading aims to identify efficient entry points to ride the current trend. Moving averages are great tools for spotting these levels and we will show you some examples in this lesson. Moving averages are tools that provide entry and exit signals. Let's start with the entry signals.

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Traders enter positions when the price breaks above the relevant moving average levels like the 9, 22, 50 and 200 Moving Averages act as support and traders buy its support when the price pulls back towards the relevant moving averages. Now let's look at the exit signals. Moving averages can be used as exit levels or stop losses on an ongoing trade. If the price breaks some important moving averages like 50 or 200 day, it could be A sign of a change in trend. Now let's move on to more practical examples of how we use moving averages.

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In this lesson, you will learn how to use moving averages as entry and exit points, as support and resistance levels, and how to use them to spot trend changes. Moving averages are very useful tools for locating points of interest on the chart. Before starting, we need to clarify some fundamental points. Moving averages are lagging indicators. They are based on past prices and therefore cannot always predict the future.

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The longer the period of the moving averages, the longer the signal delay will be. We use fast moving averages like the 9 EMA and 22 EMA and slow moving averages like the 50 SMA and 200 SMA. We will talk about the crossover strategy of fast moving averages with slow ones. This strategy can be applied during a strong trend, but it does not work during a sideways trend. In finance we always talk about the concept of mean reversion.

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The price tends to retrace towards the mean. Using moving averages here can help us capture entry points efficiently. These are some practical examples that we will cover in this lesson. Each example will help you understand how to leverage moving averages to your advantage. Our typical setup when looking at a chart is through the use of four moving averages.

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Too fast and too slow. 9 EMA, 22 EMA are the fast ones and 50 SMA and 200 SMA are the slow ones. Let's analyze them individually. The nine period exponential moving average is an indicator of the stability and direction of the current trend. In a strong uptrend, the price of an asset tends to be above the 9 EMA.

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This is an excellent signal of momentum and confirmation of the current trend. As we can see in this example. In a strong downtrend the price tends to move below the 9 EMA. The price will then tend to retrace towards the mean and this can provide excellent entry opportunities in the case of directional trends. In this example, we can see several entry points in the vicinity of the moving average.

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However, if we are in the presence of strong volatility, this approach does not work. We see it in this example. The price tends to move above and below the 9 period exponential moving average. Being a fast moving average, it can cause false signals in periods of high volatility. The nine EMA can also be used on intraday timeframes.

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It offers interesting entry signals during a move within the trading sessions. Let's look at some examples of intraday movements with a 15 minute timeframe. In this example we see a downtrend on the salesforce stock. The white circles represent a retracement to the nine period exponential moving average and signals for potential shorts. Another way to use the 9 EMA in intraday periods is through the price break above the 9 EMA.

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Here we look at the Nvidia intraday chart. The long signal is when the price breaks the nine EMA from the bottom to the top. The price then tends to retrace to the 9EMA before continuing the trend. We monitor the 9 EMA to be able to stay in the correct direction of the market. The nine EMA can also be used as a trailing stop signal in a winning trade.

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We use the nine period moving average to lock in our profits before a trend reversal. One thing to always note is that the 9ema is a fast average and can provide false signals in times of high volatility. The 22 days EMA is an intermediate moving average and serves to provide more space to traders and avoid false signals. One of the problems of the 9 EMA is the fact that it could lead to stops, especially in periods of volatility. We like to use it as a trend trading tool and avoid exiting the trade too soon.

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The 22 EMA is also a signal of the potential start of a trend change. If price is close below the 22 EMA in an uptrend, it can signal the start of a downtrend. The 50 day simple moving average is a moving average that outlines a support or resistance point in a strong bull market. The 50 period moving average acts as a support. The 50 moving average offers interesting entry points during bull market pullbacks like in this example.

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It is a first sign of what is called buy the dip or buying when the market collapses. In the idea that we are still in a trend phase at the same time in a downtrend. This moving average acts as resistance and offers opportunities to sell. The 200 day moving average represents the point of interest for the long term trend. It is a key point of support and resistance.

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It helps traders identify entry and exit points. It is the most observed moving average by investors. One of the most used strategies is to stay long until the price is above the 200 SMA. Like in this example of Tesla. If the price ends below the 200 SMA, this is a first important starting signal of a possible trend reversal.

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We use it in two as entry points into a trade and as a signal for a potential reversal point. One of the strategies most used by traders to identify the beginning of a trend is the crossover of moving averages. In particular the crossover of a fast average with a slower One the strategy is typically used to enter a buy trade when the fast average crosses low to high with the slow average and exit when the fast average crosses high to low. Like in this example, a crossover strategy allows you to stay in the trade longer in a trending period. They'd offer a better signal than using a single moving average as we see in this example we use the crossover of the 9 period exponential moving average with the blue line with the 22 period exponential moving average or green line.

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In this case, we are in the presence of a strong trend and the crossover provides us with important entry and exit signals. However, while the crossover works very well in points with a defined trend, it does not work in periods of horizontal trend. We have already mentioned how moving averages offer lagging signals as they are calculated on past prices. In this example we can see some false signals that would lead us to losses. The most used crossovers are the following.

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Traders monitor these crosses as could bring signals for their strategies. The last one is perhaps one of the most important. It is called the golden cross and represents the cross of the 50 day simple moving average with the 200 days. Let's look at this example and how we can get entry signals using the golden cross. In this example on apple chart, the crossover provided a buy signal and the beginning of a long term uptrend.

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The crossover itself in a downtrend is called a death cross. Another way to use moving averages and similar to the crossover of two moving averages is is the price crossover with a moving average. The price crossover with significant moving averages like the 22, 50 and 200 offer attractive entry points. Let's look at these two examples. The first in an uptrend.

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In this case, the crossover occurs from bottom to top. We can use the same top to bottom crossover as a potential output point. The second in a downtrend and a short signal. As you can see, we have a cross from top to bottom. Price crossover of relevant moving averages is a great way to benefit from the start of a new trend or as a signal of trend reversal.

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A nice way of using moving averages is as a trend confirmation. The moving averages, especially the slower ones like the 50 and the 200 are an excellent indicator to confirm the trend. We have seen how to draw a trend line, but very often we can use moving averages as supports and resistances in conjunction with the trend line. Let's look at an example of an uptrend. The price retraces towards the Trend line.

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The 200 period moving average provides support and an additional indication of trend confirmation. The Convergence between trend line and simple moving average provides a stronger signal. Another use case of moving averages is to look for alignment in a perfect trend. As we said at the beginning, we used a setup with four moving averages. The 9, 22, 50 and 200.

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Two of them are fast and two of them are slow averages. The reason why we use four of them is the following. In a trending market, the moving averages tend to be in line. In a Strong Uptrend, the 9 moving average must be above the 22, which is above the 50 moving average and which is above the 200 moving average. As in this example, when the moving average structure is broken, this can be an initial sign of a weakening trend.

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In this type of market, we want to enter a pullback point and stay in the trade as long as the trend structure remains intact. Now let's look at moving averages as support and resistance levels. We use the slower moving averages to find opportunities to go long or short. If the price is above the moving average in an uptrend, then we can look for buy opportunities. If the price is below the moving average in a downtrend, we look for short opportunities.

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The 50, 100 and 200 days moving averages provide great support and resistance levels. In this example, we see support in an uptrend and how the 200 moving average acts as support. Moving averages can also be used to spot trend reversals. As we saw at the beginning, the price break and a moving average can signal the change or weakening of the trend. The moving averages to keep an eye on are the 50, 100 and 200.

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A break of these levels signals the trend reversal. When in a trade we can use moving averages as take profit or stop loss targets. For example, the 22 or 50 can provide a good level of support or resistance and and an early signal of a trend change. If we are therefore in profit, we do not want to risk losing what we have earned. In this example, we enter a trade when the price crosses the 22 moving average and use the same moving average as the take profit target.

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The last example is to use moving averages in combination with other indicators like MACD and rsi. We have different types of indicators and we can combine them with each other. Moving averages are a trend indicator. We can use them in conjunction with momentum indicators. We will talk about RSI and MACD in a separate lesson.

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Let's look at this example and how you can get confirmatory signals using multiple indicators. This concludes the lesson on moving averages. In the next lesson we will look at the other indicators we use for our trading.