At the end of each lesson we look to make sense of the “inner workings” of each indicator by showing you how a particular concept or indicator can make you money.
Now we’ll get into the nitty-gritty of using moving averages to generate trading signals, and how you apply what you’ve learned to make money.
Applying a moving average to a chart is as easy as clicking the option in a trading program, but there’s a little more to it than just clicking a button. You need to decide how many periods to include in your moving average.
Moving Average Settings
- 10 and 13 – A period of 10 and 13 are great for short-term moving averages. Ten is popular for daily charts, since it includes 2 weeks’ worth of the five busiest trading days, Monday through Friday. Additionally, 13 is common for weekly settings, since 13 weeks is equal to a quarter of the year.
- 25 – Why 25 is a popular setting remains a mystery. But we humans like “round” numbers. In the sense that 25 is 1/4th of 100, it’s pretty round. It’s also fairly close to one-half of a year if you use weekly bars or candlesticks.
- 50, 100, and 200 – The 50, 100, and 200 period settings are great for a longer term horizon. Fifty is close to 52 weeks in a year, and it’s also 10 weeks’ worth of the busiest trading days. 100 through 200 are multiples of 50, so they work well for including more time into the moving average for smoother lines.
Moving Averages for Support and Resistance
Moving averages that use any number of periods work as excellent support and resistance indicators. In the chart below, we’ve used a 25 period moving average to provide support and resistance:
When the price moves through the SMA and stays above, it’s a good time to be a buyer! When the price falls below the SMA, it’s a good time to be a seller. In this way, the SMA acts as a simple support and resistance indicator. Buy above the SMA; sell below!
However, this isn’t always the case, as you can see from this chart:
The price broke through the moving average standing in as support three times. The first two movements were very serious moves through the line, yet the price always recovered. In fact, had you traded these three breaks through SMA support, you would have lost on each trade! The price just kept going higher.
What do you do about these failures? You throw them out! But how do you know when the moving average is telling a lie? You ask two of them!
In the next lesson in this chapter on moving averages, we’ll turn to the moving average cross, which is an excellent way to confirm buying and selling points while throwing out the faulty signals. One moving average can lie, but two moving averages can’t lie for the other moving average.
Proceed to the next article on moving average crosses.
