Moving averages help us to first define the trend and second, to recognize changes in the trend. That’s it. There is nothing else that they are good for.
Many traders will try and get cute using all kinds of various combinations and really it is just a waste of time.
You do not have to keep adjusting the period of a line on a chart hoping to find the Holy Grail. It isn't there!
I won’t be getting into details about how they are constructed. There are about a zillion websites that will explain the mathematical make-up of them. But all you really have to know is that a moving average line is just the average price of a stock over time. That's it.
The Two Moving Averages
I use two moving averages: the 10 period simple moving average (SMA) and the 30 period exponential moving average (EMA). I like to use a slower one and a faster one. Why? Because when the faster one (10) crosses over the slower one (30), it will often signal a trend change. Let’s look at an example:
You can see in the chart above how these lines can help you define trends. On the left side of the chart the 10 SMA is above the 30 EMA and the trend is up. The 10 SMA crosses down below the 30 EMA in late February and the trend is down. Then, the 10 SMA crosses back up through the 30 EMA in April and the trend is up again - and it stays up for several months thereafter.
Here are the rules for defining trends:
Focus on long positions only when the 10 SMA is above the 30 EMA. Focus on short positions only when the 10 SMA is below the 30 EMA. It doesn't get any simpler than that and it will ALWAYS keep you on the right side of the trend!
Note that moving averages only work well when a stock is trending - not when they are in a trading range. When a stock (or the market itself) becomes "sloppy" then you can ignore moving averages - they won't work!
Here are the important things to remember (for long positions - reverse for short positions.):
1.The 10 SMA must be above the 30 EMA.
2.There must be plenty of space in between the moving averages.
3.Both moving averages must be sloping upward.
The 200 Period Moving Average
The 200 SMA is used to separate bull territory from bear territory. Studies have shown that by focusing on long positions above this line and short positions below this line can give you a slight edge.
You should add this moving averages to all of your charts in all time frames. Yes. weekly charts, daily charts, and intraday (5 min, 60 min) charts.
