Moving Averages Explained: Stop Guessing, Start Trading Smarter!

Ever feel like you're just guessing when you're trading? I get it. It's like throwing darts in the dark. But what if you could actually see where you're aiming? That's where moving averages come in.

We're going to break down moving averages in a way that's easy to understand. No complicated stuff, just the info you need to make smarter decisions. Ready to ditch the guesswork? Let's dive in!

What's a Moving Average?

Okay, so what exactly is a moving average? Simply put, it's a way to smooth out price data over a specific period. Think of it as an average of the price over time. Instead of just looking at the price right now, you're seeing the average price over the last, say, 10 days, 50 days, or even 200 days. Different moving averages use different time frames, giving you different perspectives on the price action.

SMA vs. EMA: What's the Difference?

There are two main types of moving averages you'll hear about: the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). Let's break 'em down:

Simple Moving Average (SMA)

The SMA is the most straightforward. It takes the average price over a specific period, giving equal weight to each price point. So, if you're looking at a 10-day SMA, it adds up the closing prices for the last 10 days and divides by 10. Easy peasy!

Most of the time, it's based on the closing price of each day. Some traders might tweak it to use the opening price, but closing price is the usual way to go.

Exponential Moving Average (EMA)

The EMA is a bit fancier. It still calculates an average, but it gives more weight to recent price data. This makes it more responsive to current price changes. So, if the price has been trending up lately, the EMA will react faster than the SMA.

Think of it this way: the EMA is like that friend who's always up-to-date on the latest trends, while the SMA is more like the friend who's a bit slower to catch on.

Visual Comparison on AMD

Let's look at an example using a monthly chart of AMD. In the video, the 10-period SMA is shown in yellow, and the 10-period EMA is in purple. You can see slight differences between the two moving averages.

For example, on April 3rd, the SMA might be around $84.40, while the EMA is closer to $78.96. Why the difference? Because the EMA is giving more weight to the recent price action, which might be lower than the average price over the entire period.

Long-Term Holding Strategy

Now, how can you actually use moving averages in your trading? Here’s one strategy I like to use for long-term holds and swing trades, using the 10 SMA on a monthly chart.

The Strategy

Here's the basic idea:

• Entry: Buy when the price closes above the 10 SMA on the monthly chart.

• Exit: Sell when the price closes below the 10 SMA on the monthly chart.

The key is to stick to the rules! Don't get emotional and bail out early. Let the moving average guide your decisions.

Example 1: The 2018 Trade

Imagine you bought AMD back in 2018 when it closed above the 10 SMA, around $13.19. If you held that position, following the rules, you wouldn't have sold until the price closed below the 10 SMA several years later, around $80. That's a sweet profit from a long-term hold!

Example 2: A More Recent Trade

Let's say you bought AMD more recently, around $93.50. At one point, the price dipped, and you might have been tempted to sell, taking a $10 loss. But if you stuck to the strategy, you would have held on and watched the price climb to $165!

Eventually, you would have exited around $109, missing some of the peak but still making a good chunk of change.

Validating the Strategy

Now, this strategy isn't a magic bullet. It won't work for every stock. You need to test it out and see if it aligns with your goals. Try applying it to different stocks and see how it performs.

Improving the Exit

One thing to keep in mind is that the exit criteria might not be perfect for every situation. You might want to use other indicators or tools to help you refine your exit strategy and squeeze out even more profit.

Intraday Trading with Moving Averages

What about shorter-term trading? Can moving averages help you on an intraday chart? Absolutely! But there are a few things to keep in mind.

The Problem with "Spaghetti Charts"

Have you ever seen a chart with so many moving averages that it looks like a plate of spaghetti? It's overwhelming! Too many indicators can make the chart cluttered and hard to read.

When you're trading intraday, you need a clean chart so you can react quickly to price action.

Moving Averages as Execution Indicators

Instead of using moving averages as your main indicators, think of them as execution indicators. Use them to confirm your trading decisions, not to make them for you.

For example, you might look for crossover patterns or areas where the price is interacting with a moving average.

Stacking Moving Averages

One cool trick is to "stack" your moving averages. If you're looking to short a stock, you want the 200 EMA above the 50 EMA, which is above the 21 EMA, which is above the 9 EMA. When the moving averages are stacked like this, it can give you a clearer signal.

Using 50 and 200 EMAs

Let's say you're looking at a one-minute chart and you see the price hanging around the 50 and 200 EMAs. Then, it creates a lower high and fails below them. That could be a sign that the price is headed lower.

If you add VWAP (Volume Weighted Average Price) to the mix, you might see that it's acting as additional resistance. The 200 EMA above the 50 EMA can also confirm the negative price action.

Crossover Strategy Limits

Waiting for the next crossover to exit a trade isn't always the best idea. You could miss out on a lot of profit. For example, if you buy at $99 and the price drops to $96 before crossing over again at $98, you just lost money.

"If-Then" Statements

Combining moving averages with other "if-then" conditions can increase your chances of success. If you see the moving averages moving in the direction you think they're going to trade, it can give you confidence to pull the trigger.

Price and Volume

Remember, price and volume are the most important things to consider. Moving averages are just tools to help you confirm your trading decisions.

Using Moving Averages on the Daily Chart

Okay, let's zoom out and look at the daily chart.

Support and Resistance

The daily chart is great for finding support and resistance levels. Moving averages can act as dynamic support and resistance. For instance, the 50 and 200 period moving averages can provide key levels.

Downward Pressure

If you see the 50 and 200 period moving averages trending downwards, it indicates downward pressure on the price. If the price is also approaching a support level, it could be a sign to look for short trades.

Golden Cross and Death Cross

Here's where things get interesting!

• Golden Cross: When the 50-period moving average crosses above the 200-period moving average. This is a bullish sign! It means short-term momentum is stronger than long-term momentum, and the price is likely headed up.

• Death Cross: When the 50-period moving average crosses below the 200-period moving average. This is a bearish sign! It indicates negative correlation and downward pressure on the price.

Aggressive Entries

Want to get in on a trade earlier? Try using a smaller moving average, like the 10 EMA or 10 SMA. You can enter when the price breaks above the smaller moving average and exit at the 50 SMA.

Wrapping Up

Alright, we covered a lot! Moving averages are powerful tools that can help you make smarter trading decisions. Whether you're a long-term investor or an intraday trader, understanding how to use moving averages can give you an edge.

Experiment with different moving average strategies and find what works best for you. And don't forget to combine them with other indicators and tools to confirm your trades.

Now, go out there and put these strategies to the test! And hey, if you found this helpful, give it a thumbs up and subscribe for more trading tips. Happy trading!