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The shorter the period of your moving average, the more sensitive it will be to price
movements.
You can use 2 moving averages of different periods to generate bullish or bearish
signals. When the shorter MA crosses above the longer MA, it is a positive signal
that the stock is moving up. When the shorter MA crosses below the longer MA, it is
a negative signal that the stock is moving down.
Shorter MA crosses above the longer MA = bullish cross
Shorter MA crosses below the longer MA = bearish cross
An example is to use 2 MA with different periods. One moving average has a period
of 25 and another has a period of 50. When 25 is above 50, the stock is bullish.
When 25 is below 50, the stock is bearish. You can use this to generate entry and
exit signals.
Having learnt about bullish and bearish crosses, we can now use them in pairs. One
way to do it is by having a pair of MA for the short term and another pair for the long
term.
When a trend is changing, the short term MA will always react faster than the long
term MA. Thus we can use the short term pair as the 1st signal and the long term
pair as the confirmation signal.
Examples are 20 & 40 for the short term and 50 & 100 for the long term.
You can also use MA in triples. Here is another method showing how versatile
moving averages are.
You could use periods of 15, 50, 150. The shortest MA will always react fastest to
price action. For example at the start of an uptrend:
As a stock moves up or down, they never move directly up or down. There are dips
and peaks as a stock moves. This is because investors are constantly selling or
buying new positions, thus you get the pullbacks (uptrend) and throwbacks
(downtrend).
One thing you could use MA is to help you reduce your risk when you enter a stock.
It is best to enter when the stock is near the moving average as the stock will always
tend to retrace to the MA as it move. This is due to the normal ebb and flow of the
market.
Some popular periods that investors like to use for moving averages are
These are just guidelines as the days are up to your own preference. It also depends
on the timeframe that you intend to invest for. Some people would use 50 as their
short term and 150 as their med term MA. Others will decide to use the 15 & 30 day
as their short term MA.
Ultimately you have to try it yourself to see which period fits your strategy best. Even
adjusting the periods to a 33 day and 67 day MA will be fine. This slight difference in
the periods should not affect your returns because moving averages are just one
portion of your entire strategy.
Using MA also means you will miss the start of a trend as you have to wait for the
signal from the moving average will only come when the trend is established. This
might cause you to miss out on some of the early profits from the trend.
To put it simply, the EMA is more responsive to recent price changes compared to
the SMA.
You can experiment on your own and decide which kind of moving average you
prefer, one is not necessary better than the other.
To Sum up this lesson
A moving average is an indicator that shows you the general direction a stock is
moving towards.
The period of a moving average refers to the number of days of the moving
average.
The shorter the period, the more sensitive a moving average will be.
A bullish cross by the moving average occurs when the shorter moving average
crosses above the longer moving average.
A bearish cross by the moving average occurs when the shorter moving average
crosses below the longer moving average.
Moving averages can be used in pairs or triples.
It is best to enter a stock only when the price is near the moving average, to
reduce your risk.
Moving averages should be used with other tools in your strategy to increase
your odds of success.
Moving averages work best in a trending market and can provide a lot of false
signals in a sideways market.
The difference between a SMA and an EMA is the EMA is more sensitive to
recent price changes.
Moving averages can also be used as support and resistance, here is an article
illustrating this.