Last Updated: Wednesday, February 3, 2016

How to trade with Moving Averages


'Simple Moving Average' -(SMA)

'Simple Moving Average' is a simple arithmetic moving average which is calculated by closing price of the stock. While calculating SMA for desired period, day closing price of the stock for such period is added together, then it is divided by  a number of trading sessions. It is also known as 'Daily Moving Average' (DMA). Most of the day traders use 5 DMA to 30 DMA for very short term trading while 50 DMA to 200 DMA is used by medium to long term trading/investment ideas.

'Exponential Moving Average' (EMA)

'Exponential Moving Average' is a type of moving average which is almost similar to a 'Simple Moving Average (SMA), but more weight is given to the latest trading prices. As this moving average is based on weighted, EMA is also known as Exponentially Weighted Moving Average (EWMA) or 'Daily Exponential Moving Average' (DEMA).  'Exponential Moving Average' reacts faster to recent price changes than that of  'Simple Moving Average' (SMA/DMA). Most of the day traders use 10 DEMA to 20 DEMA as it is the most popular short-term averages, while the 50 DEMA and 200 DEMA are used to measure long-term trends. Read more: Exponential Moving Average (EMA) Definition

Short term and Long term Moving Averages

Traders often examine short term moving average on a trading chart because it responds quick movement of stocks to a new trend. While investors go with a long term moving average because they think it reduces errors and deliver accurate trend on chart.

Using two moving averages on chart

Most of the smart traders use both the moving averages simultaneously, If you want to see how it works, simply wait for a shorter moving average i.e. 5-DMA to cross a longer moving average i.e. 20-DMA. By doing so you let weekly moving average (5-DMA) to cross monthly moving average (20-DMA) on chart. 
  • How to Trade with Moving Averages
Trading Tips; One should Buy if a shorter moving average crosses the longer one in upside movement and should Sell if the shorter moving average crosses the longer moving average in downside movement.

trading-with-moving-averages-'Exponential Moving Average'-'Simple Moving Average-(SMA)

In above figure black curve denotes longer moving average(20-DMA)  and red curve shorter moving average  (5-DMA), you may see how the stock behaves after 5-DMA crosses 20-DMA at arrow mark. This arrow mark in above figure is a crucial buy/sell crossovers.

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