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How to Use Moving Averages in Trading

How to Use Moving Averages in Trading

While fundamental analysis is the study of a market’s potential value, technical analysis is the study of the behaviors of the participants trading in that market. Investors are primarily focused on valuation metrics for an asset, while traders primarily trade price action. 

The majority of investors focus on price to earnings ratios, sales growth, earnings growth, and supply and demand when trying to value markets. Technical traders look at price action on charts to see what price levels the other market participants are buying and selling. Moving averages is a price filter for traders to get a wider view of trends than just price alone. 

Your goal as a trader is to develop ways to capture trends inside your time frame, through quantified methods based on proven principles and back tested market studies. Moving averages are one of the best tools for quantifying this. The incorporation of moving averages as trading signals removes much of the emotions and opinions that tend to get traders into trouble.

Moving averages are great guides for entries, exits, position sizing, and providing a filter to view the actions of buyers and sellers in a market. Price is the result of an agreement between the buyer and the seller at any given moment. Your purpose is to be on the right side of key moving averages as a market or asset is being accumulated or distributed, inside your trading time frame. 

Profitable trading is the result of making better decisions than the majority of traders that are on the wrong side of a key moving average in your market. 

Some quantifiable signals for entering trades:

•A key moving average does not hold as support for a long position

•A key moving average that has acted as resistance is broken through on a short position

•It gives a trader better odds to stay in a good trade if you set your stop a few percent below a key moving average to avoid the obvious levels being hit

•An end of day stop, if price closes on the wrong side of your key moving average

•A next day stop, you close a position on the next open if your key moving average is violated

•A moving average crossover

Potential ways to set a trailing stop:

•If you enter a trade based on a longer term moving average like the 100 day or the 200 day, and it has gone into an extended profit, you can move your stop up to the 5 day or 10 day moving average

•Set a trailing stop at a loss of the previous day’s low or high of day

Exit with Profits:

•Price crosses back under your initial moving average after holding it through a profitable trend

•The RSI can be used to exit a trade for maximum profit after entering based on a moving average

•Exiting your position when it becomes overbought or oversold

•Exit if the Bollinger Band is broken

•Exit if your profit target is reached

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