Quick guide for Using Moving Averages
Moving averages [MA’s] are among the most important financial and stock trading indicators a trader can have in their arsenal. Moving averages can help identify trends and reversals and this alone can be enough to help you profit from the markets. What’s more is that they, [Moving averages] can also offer clarification to support and resistance levels.
The fact that much of my trading success has revolved around using moving averages at some stage, is enough to tell you that they work and that they are very simple to use.
But… stating the fact does not give them the true credit that they deserve.
Most traders know the importance of trends, and the moving average are the key indicator that can be used to identify trends.
MA’s are what are classed as lagging indicators. This means that they are formed from historic data, meaning that they can help you speculate where the price is likely to go not where the price is going to go.
Moving Averages work by smoothing out the past data to create lines that make the price of a chart easier to identify with.
Investors can hold a trading position when they can see that the price is above or below their moving average/s.
Different Kinds of Moving Averages
The two most common types of moving averages include the SMA and EMA. SMA stands for the simple moving average, while the EMA stands for the exponential moving average. There are differences and similarities between the two.
Simple Moving Average SMA
The Simple Moving Average or SMA, is calculated by adding the closing price of the security for a number of time periods and then dividing this total by the number of time periods. This is [unsurprisingly] the most basic of the moving averages.
Exponential Moving Average EMA
The Exponential moving average [EMA] is very similar to that off the simple moving average. However, the difference is in their sensitivity to market movement. The EMA will track and hug the price of the security, far closer than that of the SMA.
The EMA is more suited for shorter term trading [10 minute- 1 hour charts] and you will often see Day Traders using them in their set ups.
The SMA is slower to react to market price, therefore it can keep you in the trade longer with less false price movements, but can also get you into a trade later too. The SMA is preferred by medium to longer term trend traders that use end of day charts.
Weighted Moving Average WMA
The weighted moving average is calculated in the same way as the simple moving average is calculated. However, there are differences in the value. The values/price can be linearly weighted. This ensures that recent prices of the given security impact more on the average.
Some traders prefer the WMA moving average as it is that bit faster again at identifying price movements than the EMA. It can be more useful in a faster moving market where you are using 1 or 5 minute candles for example.
VIDYA Moving Average
The most recent addition to the moving average family is the VIDYA, which stands for Variable Index Dynamic Average. This moving average is commonly credited to Tushar Chande.
The VIDYA moving average is unique in the sense that it adjusts itself when there are changes in market volatility. When there is higher volatility the VIDYA reacts by becoming more sensitive. In periods of lower volatility, you’ll see the VIDYA less sensitive to market conditions.
The VIDYA is a combined indicator of the exponential moving average and the Chande momentum oscillator.
The VIDYA moving average is an indicator that I see a huge potential for traders, especially new traders. It [the VIDYA] takes a lot of false movements out off your trading when using the appropriate timeframes.
This means that you will come accustomed to riding the trading waves [price movement] without so much conflicting emotion.
When Vince Stanzione first started using the VIDYA I really wasn’t a fan. Now… I’m going to be basing far more emphasis on trading with it.
Why the shift in opinion? Because it’s awesome, and I’ve been back testing recently and it makes trading even easier.
You won’t find the VIDYA on many chart packages at the moment though. Sharescope have it pre installed however.
Most of the other chart packages are still playing catch up on installing the VIDYA as it is quite a complicated bit of programming to do [apparently].
Moving averages smooth out price to make it easier to identify trends
Simple moving averages are the slowest moving averages to react to price movements and are therefore better for trading medium to longer term trends.
Exponential Moving Averages are useful for trading shorter time frames as the EMA will track the price closer than that of the SMA .
Weighted moving averages are better for fast day trading strategies and fast moving markets.
The VIDYA moving average is a combination of the EMA and an Oscillator. This moving average will keep you in trades longer with less chance of stops being hit and false signals
Remember, the faster the time frame of the charts and moving averages that you use, the more you will need to be prepared to deal with false trading signals.