A moving average is an average price for a trading instrument over a set time frame. they are technical tools used on charts for trend identification. They can be used as standalone lines for trend trading, or in conjunction with other technical indicators like RSI and Bollinger bands. Moving averages are one of the building blocks to learning technical analysis and I think they are the most important. Moving averages are an unbiased trend indicator which makes trend lines subjective, Moving averages are quantifiable facts.
Simple Moving Average (SMA)
A simple moving average is an indicator that shows a line on a chart based on the calculation of the average price of a trading instrument over a set number of time periods. A 5 day SMA is the average price over a 5 day period. If something ended the last five days at $1,$2,$1.50,$1.75 and $2.25 the 5-day simple moving average would be $1.70. This shows that $1.70 was the average price over the past 5 days.
This is the line that strong leading stocks start to pull back to. It is usually the support level for strong uptrends. When markets are on the rise it is normal for them to pull back to this resistance line which makes this level a great “Buy the dip” level. The 50 day SMA can keep you in growth stocks under money manager accumulation for months. A stock trading under the 50 day SMA means it is likely under distributed and the odds for a long term trade are better.
- The 50 day SMA can keep you in winning trades for months
- The 50 day SMA provides a support level for buying the dip
- The 50 day SMA is usually the pullback to resistance line at the start of downtrends
- In strong trends, the price tends to move far away from the 50 day SMA
The 100-day moving average is perceived to be the dividing line between a stock that is technically healthy and one that is not. This is the line that provides support between the 50 and 200 day. If it does not hold as support there is a high probability that the 200 day SMA is the next stop. This indicator shows a deeper pullback level in bull markets and uptrends. It usually presents a great risk/reward ratio in bull markets. When the 100 day moving average coincides with 30 RSI the odds are greatly increased for a winning trade. (Side note: When RSI hits 30-35 it means a stock is being oversold)
- If the 50 day moving average is lost, the next level to look to “buy the dip” is the 100 day SMA
- If the price stays under the 100 day SMA for a number of days, the greater the chance it will trend down to the 200 day SMA
- There is a good chance that the market will retrace to the 100-day SMA several times a year, even in bull markets. This is normal and no reason to panic sell thinking the trend is over
200-day SMA (The Bull’s Last Stand)
Staying on the right side of a long term uptrend can be as simple as staying long on a stock above the 200 day SMA, and going to a cash position below it. A loss of the 200-day is your first warning of a possible correction,down trend or bear market, implementing this to your rules will save you from large losses. When investors are trapped in cash and are looking for a reentry the first break, and close above the 200, presents a good risk/reward entry at the beginning of the next POSSIBLE bull market. Markets that have long term downtrends must first cross the 200-day SMA before any damage can be done. If investors were using this indicator in the 2008-2009 recession this technical signal would have saved investors a TON of money. Long term trend followers should not be buying positions under the 30 RSI
- The beginning of up trends and bull markets generally start as price breaks above 200 day MA
- The first sign of the beginning of a bear market is when price breaks and stays below the 200-day SMA
- Bad things happen to long positions under the 200-day SMA
As a long term investor moving averages could help a lot when trying to identify trends and to get good entries when buying the dip on the S&P. I feel that pairing moving averages with RSI (Relative Strength Index) is one of the best ways to find a solid exit or entry into a position. a 200-day moving average may be a better choice than the 50-day. By now, this paper has established that using moving averages can reduce portfolio volatility. … If the 50-day average crosses above the 200-day, a buy signal is given.
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