Tips for Buying Stocks Using a Moving Average (Detailed Guide)

 With the help of a continuously updated average price, the moving average (MA), a straightforward technical analysis tool, smoothes out price data. The standard is calculated over a given time period, such as 10 days, 20 minutes, 30 weeks, or any time period selected by the trader. There are benefits to employing a moving average in your trading and many types of moving averages to choose from.

Tips for Buying Stocks Using a Moving Average (Detailed Guide)

Using these methods is especially popular because they can be customized to any time frame, making them appropriate for both lengthy and short-term investors.

Additionally, a moving average can serve as support or resistance. In an uptrend, a 50-day, 100-day, or 200-day moving average, as seen in the picture below, might operate as a support level. This is due to the fact that the average functions as a floor (support), and the price bounces up off of it. A moving average may serve as resistance during a downturn; like a ceiling, the price may hit the level before beginning to decline once more.

Reasons to Use a Moving Average

On a price chart, a moving average reduces the amount of noise. Examine the moving average's direction to get a sense of which way the price is trending. If it is slanted upward, the price is moving upward (or was recent); if it is inclined downward, the price is moving downward; if it is moving laterally, the price is likely in a band.

Additionally, a moving average can serve as support or resistance. In an uptrend, a 50-day, 100-day, or 200-day moving average, as seen in the picture below, might operate as a support level. This is due to the fact that the average functions as a floor (support), and the price bounces up off of it. A moving average may serve as resistance during a downturn; like a ceiling, the price may hit the level before beginning to decline once more.

Tips for Buying Stocks Using a Moving Average (Detailed Guide)

Price does not always follow the moving average in this manner. Prior to reaching it, the price may run through it somewhat or halt and turn around.

In general, if the price is above a moving average, the trend is upward. If the price is lower than the moving average, the trend is downward. Moving averages, on the other hand, can have varying lengths (explained more below), thus one MA may suggest an uptrend while another MA shows a fall.

Moving Average Varieties

There are several methods for calculating a moving average. A five-day simple moving average (SMA) adds the five most recent daily closing prices and divides the total by five to get a new average every day. Each average is linked to the next, resulting in a single flowing line.

The exponential moving average is another common form of moving average (EMA). The formula is more complicated since it gives greater weight to the most recent pricing. Due to the increased weight given to current price data, the EMA responds to price changes more swiftly than the SMA does if you display a 50-day SMA and 50-day EMA on the same chart.

Moving averages are calculated automatically by charting software and trading platforms, so no manual math is necessary.

Tips for Buying Stocks Using a Moving Average (Detailed Guide)

There is no one form of MA that is superior to another. For a time, an EMA may perform better in a stock or financial market, while an SMA may perform better at other periods. The time duration chosen for a moving average will also have an impact on its effectiveness (regardless of type).

Length of the Moving Average

Moving average lengths that are commonly used include 10, 20, 50, 100, and 200. Depending on the trader's time horizon, these lengths may be applied to any chart time frame (one minute, daily, weekly, etc.). The time frame or duration of a moving average, often known as the "look-back period," can have a significant impact on its effectiveness.

A short time frame MA will respond to price fluctuations significantly more quickly than a large look-back period MA. In the graph below, the 20-day moving average closely reflects the real price more closely than the 100-day moving average.

A shorter-term trader may gain analytically from the 20-day moving average since it tracks the price more closely and hence causes less lag than the longer-term moving average. A longer-term trader may benefit more from a 100-day moving average.

Tips for Buying Stocks Using a Moving Average (Detailed Guide)

The time it takes for a moving average to identify a probable reversal is referred to as lag. Remember that when the price is above a moving average, the trend is deemed upward. When the price falls below that moving average, it indicates a possible reversal. A moving average of 20 days will produce far more reversal indications than a moving average of 100 days.

The duration of a moving average is unlimited and ranges from 15 to 89. It may be possible to improve future signals by modifying the moving average to provide signals based on prior data that are more accurate.

Crossover Trading Strategies

One of the most used moving average tactics is crossovers. The first kind is a price crossover, which occurs when the price crosses above or below a moving average to indicate a possible trend shift.

Tips for Buying Stocks Using a Moving Average (Detailed Guide)

Applying two moving averages to a chart, one longer and one shorter is another tactic. When the shorter-term MA crosses above the longer-term MA, it suggests that the trend is turning upward. This is referred to as a golden cross. Meanwhile, a sell signal is generated when the shorter-term MA crosses below the longer-term MA, indicating that the trend is turning downward. A dead/death cross is what this is.

Disadvantages of MA

The calculation of moving averages is done using historical data and therefore has no forecasting characteristics. As a result, moving averages might provide erratic outcomes. At times, the market appears to obey MA support/resistance and trade signals, while at other times, it does not.

Another significant issue is that choppy price movement can cause the price to bounce back and forth, resulting in many trend reversals or trade signals. When this happens, it's better to take a step back or use another indication to assist define the pattern. A similar scenario can happen with MA crossovers when they become "tangled up" over an extended length of time, resulting in repeated loss transactions.

Shifting averages perform far better when there is a strong trend present than when there is choppy or range trading. Although changing the time period will temporarily solve this issue, these problems will eventually probably arise regardless of the moving average's time frame.