Moving Averages: A Brief Introduction
In the financial market, no one can predict accurately how an asset can move. In many instances, people who try to predict the future prices without any analysis fail. This is because the market is made up of complex parts that move as a result of different triggers.
To make better predictions, traders, analysts, and investors use various analysis methods. While these analysis methods are not accurate, they help the investors in making the best possible decisions.
Moving Averages (MAs) are some of the best technical tools to use to make trading decisions. There are different types of moving averages which include:
- Simple moving average (SMA)
- Exponential moving average (EMA)
- Weighted moving averages (WMA0)
- Smoothed moving averages (SMA)
- Squares moving average.
The simple moving average is simply the addition of the prices and then dividing them by the number of days.
#1 – Proper Period
The first thing you need to master the skills of moving averages is the period. In trading, you can trade charts on various timelines. It is possible to trade one-minute charts up to yearly charts. Each of these charts require different types of analysis.
A person who looks at annual or monthly charts is probably a long-term investor who wants to open trades and leave them to run for a certain period of time. As a day trader, it is irrelevant to use these charts. As such, an investor should use long term periods. In this, the commonly used period is 200 days.
A day trader will aim to enter a trade and exit within a few minutes or hours. To do this, the trader needs to have a short term chart between 5-minutes and one-hour. Then, the period used should be short as well. The most commonly used periods are 12 and 24.
#2 – Combine MAs with other indicators
Moving Averages are trend indicators, so they show a trader whether a trend has formed or not. To make efficient decisions, it is important to combine these MAs with other technical indicators. By combining two or three indicators, it will help you make better decisions.
A good strategy is to combine MAs with volume-based indicators, and oscillators. Personally, I combine MAs with stochastics, relative strength index (RSI), and accumulation/distribution.
You should strive to combine MAs with only a few indicators because doing so with many indicators will hamper your decision making. It is also important to always look at the fundamentals of any asset that you want to buy or sell.
On a daily basis, economic data is released. You should use this information together with the moving averages to make prudent financial decisions.
→Technical Analysis: Tools You Can Use
#3 – Combine Two Moving Averages
Another strategy that has been very important to me is to combine two moving averages in the same chart. In this, you combine a long-term MA (slow) and a short term MA (fast).
For instance, in a 15-minute chart, you can have a 14-day exponential moving average and a 5-day EMA. After this, you should look at the areas where the two lines cross. If the fast EMA crosses the slow EMA going up, then this is an indication of a bullish chart.
The vice-versa is true too.
#4 – Create a System
Another strategy that will help you make more from the moving averages is the use of a trading system. Expert Systems as they are known can be very helpful to you.
In the past, creating an EA required one to have a strong background in statistics and computer science. Today, various brokers provide a drag and drop platform for creating expert systems.
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When creating an expert system based on moving averages, you should have your parameters right and then put them in the system (as stated above, you can combine the Mas with other indicators).
Finally, you should implement the system in your charts so as to get signals when the points are reached. Before implementing it, you should do a lot of backtesting to ensure the system is accurate.
→How to develop a Mechanical Trading System