How To Use Moving Averages

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The topic for day 3 of  the 30 days to master part-time swing trading challenge is moving averages.

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The Concept: Moving Averages

Everybody uses moving averages. If you are reading this article, I’m sure you’ve experimented with them and have them on your charts. There are many different ways to use them, and I’ve tried just about all of them. After years of testing, I’ve discovered only three main uses for moving averages.

We’ll get to those in a second, but before we do that let’s have a quick refresher on what moving averages actually are.

Moving average show you the average price of a stock over a given period of time.

For example, if you are using the common 50 day moving average, at any given day on that moving average line, you will see the price of the previous 50 day average.

Moving averages can act as support and resistance levels. However, remember that moving averages don’t give us “real” buying and selling levels like price action does. They only work as support and resistance because many traders are using them. Thus, I call it a secondary S/R indicator, lagging behind true price action importance.

Now that we have a good general idea of what moving averages are, let me s how you how I use them as a trading tool.

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How to Effectively Use Moving Averages

Here are my  three favorite ways to use moving averages

  1. To identify trends: Moving averages help us identify markets and stocks that are in uptrends, downtrends and rangebound.
    1. Uptrend: The moving average will show a steady rising trend line
    2. Downtrend: The moving average will show a steady declining trend line
    3. Rangebound: The moving average will flatten or continually rise and fall
    4. Trend Reversals: The moving average will form a pivot and  got from flat to the opposite direction.
  2. To identify stocks that are overbought or oversold
    1. Many traders like to use rate of change indicators like RSI and stochastics to measure overbought and oversold levels in stocks and markets. My favorite method is to analyze the appropriate moving average for the time frame I am studying.
    2. Trends will usually start with the stock near the moving average. As the stock becomes extended, you will see a gap form between price action and the moving average.
    3. The wider the gap, the more likely you will see a “snap back” or “reversion to the mean”.
  3. To enter trades based off pullback entries
    1. Moving averages provide support for pullback entries.
    2. Strong stocks will hold or “remount” moving averages when tested.

There are many other ways to use moving averages, but these are the 3 most effective ways that I’ve tested. They are my only three uses for them.

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Source: bullsonwallstreet.com | Original Link

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