One of the most popular technical analysis indicators is the simple moving average also known as SMA, if you learn how to use these correctly they can be a very useful tool to help you to make good trading decisions.
The 50 simple moving average, or 50 SMA, is simply the sum of the last 50 values for each period, divided by 50, this is a moving window, as time moves on so does the average. Notice that I used the word period because this indicator works on any time period in exactly the same way.
It can be used on monthly, weekly, daily, hourly, 30 minutes, 10 minute and on whatever time period you want to monitor and trade. Although the SMA is the most commonly used there is also the exponential moving average or EMA. This is a weighted version of the formula using the mathematical exponent function to give more weight to the more recent values, this has the effect of making it a much faster average that many traders like.
The reality is that it probably does not matter if you used the SMA or the EMA, what does matter however is that you use one or the other and then be very consistent with it. Do not switch between them, it is more important that you trust your chosen indicator then a slight difference in its value.
The simple moving average is primarily used to determine what the current trend of the stock is, depending on the value used it could be a short term, medium term or long term trend. An important point to note is that moving averages are really only useful when the stock is trending, if the moving average is flat, i.e. horizontal on your chart it can become very choppy, this is a good time to stay out of the market.
The general rule is that if the current price is above the SMA the trend is up, if below the trend is down. This is very important to know because it forms the basics of trend trading and trading with the trend.
For the short term trend many traders like using a 5-8 SMA or EMA, here is a trading secret, never trade again the direction of the short term tend, this is really just common sense when you think about it.
Moving averages often act as support or resistance, many traders use the 15, 21 or 30 SMA for this purpose.
There are a number of other very important moving averages that you need to know about, these are the 50, 100 and 200 SMA, and this mainly applies to the daily and weekly charts. A lot of big players in the markets, the mutual funds, investment banks etc use the 50 and 200 SMA as support and resistance, if they decide to buy or sell based on these you need to follow suite, the 100 to a lesser extent. These are very useful averages to watch if you trade EFT’s like an Oil ETF.
A useful tip is that when a stock breaks through one moving average it will often move all the way to the next, for example, if a stock breaks the 30 it may move to the 50 before finding some support or resistance.
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