When you use moving averages, you usually have two averages that you are tracking. One is a short term average and the other is for a longer time period. You are watching for when the graph of the shorter average crosses the graph of the longer average on your chart. These usually signal times to buy or sell a security.
You calculate moving averages by finding the average price (mean) of the security for the time period you are looking at. For a 9 day average, you would add up the price each day and divide by 9. This is called a Simple Moving Average. Usually the closing price is used for the calculations. You can also weigh recent days more than earlier days using some multiplier. The easiest way to do this is to use an Exponential Moving Average An Exponential Moving Average is more sensitive than a Simple Moving Average. As such, some traders us the EMA as the short term average and the SMA as the long term average.
The down side to all trend following systems is that they do not work well when you are in a trading range or sideways market. The short term average crosses and re-crosses the long term average resulting in too many trades. The profit is too small to cover the trading costs and you generate money losing trades. That is why you would want to use trend lines and Average Directional Index to confirm you are still in a trending market, and not in a trading range.
Comment Preview