The moving averages trading strategy – like most other technical indicators are primarily used by traders in determining the trend in any given financial asset. However, with hundreds of technical indicators available in the market today, choosing one that works for you might not be an easy task, especially if you are new to trading. This said, while some indicators remain popular, very few have actually proved to be as reliable as moving averages.
The Moving Averages Trading Strategy Defined
The core functions of the moving average are to help the trader identify a trend and reversal in a financial asset, measuring the strength in the momentum of the given asset, and determining potential support and resistance levels in the asset. Put short, it helps you not only define the trend, but also recognize changes in the trend.
Using The Moving Averages Trading Strategy
While there are several moving averages available in trading, most traders will generally give preference to Simple Moving Average (SMA), and Exponential Moving Average (EMA), as a technical indicator.
Simple Moving Average Use and Settings – The Simple Moving Average is created when the closing price of an asset over a set period of time is averaged. In this case, whatever you have set your simple moving average to – your charting package will reflect the equivalent thereof, however, in the opposite direction. Here, the closing price is averaged and the trader is presented with the first initial dot. Thereafter, the formula will keep dropping an old period of data and add a new period of data which will give you a continuous line.
Preferred settings in Simple Moving Average: 200 periods
When the price reaches the 200 period moving average mark, you will come to find that the price will either bounce for a while. Hereafter, the price will either bounce away completely or break through.
Exponential Moving Average Use and Settings – The Exponential Moving Average trading strategy is without a doubt said to be the most popular of all moving averages. Unlike the Simple Moving Average, where preference is given to the presented data, Exponential Moving Average gives preference to recent price movement.
Preferred settings in Exponential Moving Average: 12, 26, and 200 EMA
The 12 and 26 moving average is generally used in creating the convergence divergence. The 200 moving average simply gives the trader an indication (usually via candlestick), when to sell. However, the price has to exceed the 200 moving average mark.
In which ever moving average trading strategy you choose to engage, the principle remains the same as with most other technical indicators. Since moving averages are used to determine buy and sell signals, make sure you:
- buy when the price closes above the moving average
- sell when the price closes below the moving average
If you are just getting started on trading and you are considering the use of the moving averages trading strategy, it is in your benefit to choose according to which market you find yourself to be in.