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.
What are Moving Averages?
Moving Averages (MAs) are some of the best technical tools to use to make trading decisions. Indeed, they are so popular that they are the foundation of most technical indicators like Bollinger Bands, Envelopes, Average Directional Movement Index (ADX), and MACD, among others.
Moving averages map the average price of an asset in a certain period of time. There are several types of moving averages.
- Simple moving average (SMA) – SMA, the most common type of MAs calculates the average price of an asset by the number of periods in that range.
- Exponential moving average (EMA) – The EMA removes the lag in SMAs by prioritising the recent prices.
- Weighted moving averages (WMA) – The WMA removes the lag by discounting the weight of the ‘ancient’ prices of an asset.
- Smoothed moving averages (SMA) – The smoothed moving average removes the lag by using a longer period to determine the average. It assigns a weight to the price as the SMA is being calculated.
There are other types of moving averages like the least squares moving averages, hull moving average, and Arnaud Legoux moving average, The chart below shows how the 25-day EMA, SMA, and WMA applied on the Nasdaq 100 index.
How to read the moving average
Reading the moving average is a relatively simple process. Ideally, when a 15-day moving average is below the price of an asset, it is a sign that the price is above the overall average in the past 15 days.
Similarly, when the moving average is above the price, it is a sign that the price is a bit cheaper than the overall average.
Best MA for a 15-minute chart
A 15-minute chart is usually used by day traders, who are more focused on opening a trade and closing it by the end of the day. It is never ideal for swing and long-term traders to use a 15-minute chart.
Therefore, the best MA to use in a 15-minute chart should be relatively short. For example, it does not make any sense to use a 100-period MA on a 15-minute chart. It also does not make sense to use a 50-MA for such a chart.
Instead, you should use relatively shorter-dated moving averages. For example, the chart below shows the 15-minute chart of the Nasdaq 100 with a 200-period and 25-period EMA.
You should use the 50-day, 100-day, and 100-day moving averages when you are looking at long-term scenarios. For example, when you want to buy and hold a security for two weeks or a month, you should use a longer-term moving average.
Similarly, if you are looking at short-term situations, you should look at shorter-term moving averages.
Moving Averages Strategy: How to master them
#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.
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.
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
External Useful Links
- Read more about MA on Investopedia