Moving Average (MA)

Before you get involved in Moving Averages, an absolute prerequisite is to be very knowledgable in Candlesticks. To use moving averages you must first have a Candlestick Chart, then have a Moving Average (MA) line on the Candlestick Chart, unless you use Bar Charts. An individual Bar and a Bar Chart will give the same information as an individual Candlestick and a Candlestick Chart. I use Candlesticks.  An individual Candlestick or a group of Candlesticks relative to a specific moving average line will help a technical trader make trading decisions. Technical analysis has been around for decades and through the years, traders have seen the invention of hundreds of indicators. While some technical indicators are more popular than others, few have proved to be as reliable and useful as the moving average.

Moving averages come in various forms, which we’ll get into, but their underlying purpose remains the same. The moving average will let a technical trader know where a stock has been and help the trader track the trends. The widely used indicator in technical analysis helps smooth out price action by filtering out the “noise” from random price fluctuations, helping to focus on the average closing price of multiple days to make better trading decisions. By identifying trends, moving averages allow traders to make those trends work in their favor and increase the number of winning trades. The moving average will help identify the direction of the trend and/or define possible support and resistance levels. I hope that by the time you study all pages of Main Street beats Wall Street’s “Technical Analysis” section, you will have a clear understanding of why moving averages are important, how they are calculated and how you can incorporate them into your trading strategies.

As a trader, when you are looking at a specific stock to buy or open an option position, you will look at the Candlestick Chart on that stock. On that Candlestick Chart you will want to set up Moving Average (MA) lines. You can set a moving average line averaging the closing prices of any time period. For example, let’s say you want a 5 Day Moving Average. In your “Studies” area of the chart setup you will go to “Moving Average (MA)” and type in a 5. If you have trouble with any setup you can call your broker and they will help you set up your charts however you would like. My Candlestick chart is set up with three moving averages lines in view at all times. I use the 8 Day MA, the 50 Day MA and the 200 Day MA. In the graphic above the red line is the 8 Day MA, the blue line is the 50 Day MA and the white line is the 200 Day MA. The 8 Day Moving Average is also called the “T-Line.” There is a page under “Technical Analysis” explaining each of the moving averages I use.

The two most popular types of moving averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). Above I mentioned (“You can set a moving average line averaging the closing prices of any time period”). When you have a moving average that averages the closing prices, this is a Simple Moving Average (SMA). In my example we said you wanted a 5 Day MA. If you installed a 5 Day Simple Moving Average, the line on your chart will be at the average closing price of the last 5 days. And every day the MA line will move to the average of the last 5 days. Let’s say the closing price of your stock for the last 5 days was 9, 10, 11, 12 and 15. The next day the “5 Day MA” will be at 11.40. That’s the 5 days added up and divided by 5. The 5 days added up comes to 57. The 57 divided by 5 days is 11.40. If on the 6th day the stock’s closing price was down to 13, the closing price of the 1st day (9) is no longer in the equation. Now you add 10, 11, 12, 15 and 13. The “5 Day MA” is now at 12.2. Clearly you don’t have to do the math, your stock program will automatically continue the MA line as the days pass. With this line of passing days you will be able to see the trend of the stock movement.  On day one where the stock closed at 9, it doesn’t matter if the high of the day was 12 and the low was 6. The Simple Moving Average (SMA) only uses the closing price. The highs and lows can be distracting so the moving average line helps you to focus in on the closing price of each day and that price averaged in with the 4 previous day’s closing prices.

An Exponential Moving Average (EMA) is very similar to the Simple Moving Average (SMA). The big difference is the EMA will put more weight on the most recent data and less weight on the historical data. If you have a 5 Day MA there will not be much difference between the SMA and the EMA. However, if you have a 100 Day SMA next to a 100 Day EMA there might be a big difference especially at the end of the lines where the recent data will influence the EMA more that the SMA.

I included a link from Investopedia that includes a 2 minute video that might help you understand the difference between the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). SMA and EMA video

As I mentioned, I use the 8 Day MA, the 50 Day MA and the 200 Day MA. The 8 Day MA is an EMA and the 50 and 200 Day MA is an SMA. Sometimes when looking at the SMA I’ll add the EMA to see the difference.

As you read the following pages in the “Technical Analysis” there will be pages on the Moving Averages I use. These pages will include many graphics to help explain why I use them and what I look for when making a trade.