How To Use Moving Averages
As we identified in our last blog post the primary function of a moving average is to identify trends and reversals, measure the momentum and find where support or resistance will be found. We want to cover in this post how to monitor momentum, utilizing stop losses and the capabilities you should consider when using them for technical analysis.
Being able to identify a trend is key for moving averages. Remember they do not predict new trends but confirming existing ones. As seen below this example shows an uptrend
With the price being above the moving average and is sloping up. Traders would use a price below a downward sloping average in order to confirm the downtrend. You would want to consider holding the long position when the price is trading above the moving average.
In order to measure momentum, moving averages can be used to help. If you pay attention to the time periods used that create the averages, each time period will help create insight into the different types of momentum.
Short term momentum can be seen in time periods of 20 days or less. Medium term momentum is generated between 20-100 days. If you are using 100 days or more you can call that long term momentum.
A key way to determine the strength and direction of the momentum is placing the three different moving averages onto a chart and compare the correlation.
Another use of moving averages is finding the price supports. It does not take a lot of experience to know when you are dealing with moving averages that a falling price will stop and reverse direction at the level of important averages.
Below, you will notice that using a 200 moving day average you can see that the 200-day moving average was able to bounce back after falling from its high of $32.
Here we would use other technical indicators confirming the expected move.
Once the price goes below levels of support typically the moving average can act as a strong barrier. This is one way traders take profits. They close out any long positions why your more short sellers use the averages as entry points because the price bounces off the resistance and it continues to move lower.
The support and resistance of moving averages making them awesome for managing your risk. Moving averages are able to identify strategic places for traders to set stop loss orders.
Stay tuned for more info and if you are interested check out our first post on our moving averages.