Daytrading with moving averages
One of the first things that a daytrader meets in his search after indicators for his technical analysis is the moving averages. But unfortunately, many people get it wrong on how to use the moving averages, how they are calculated correctly and also the disadvantages of this method.
In this article we will go through those three things and end it with almost an hour long video, which goes into even more depth on this important indicator.
The basics
A moving average is simply the sum of the data divided by the number of data and this calculation is then done “moving” every day. Does it sound confusing? Then take a look here.
Here is the price for a given stock 5 days in a row:
Day 1: 100
Day 2: 110
Day 3: 120
Day 4: 130
Day 5: 140
To get the average price for those 5 days we do the following:
(100 + 110 + 120 + 130 + 140) / 5 =
600 / 5 = 120
This means that the average price for the last 5 days is 120.
So what is a moving average?
Let us say that we on the 6th day get a stock price at:
Day 6: 150
We still want to calculate 5 days of average price, and we do this by not including data from day 1 and only use data from day 2 up to day 6 like this:
Dag 2: 110
Dag 3: 120
Dag 4: 130
Dag 5: 140
Dag 6: 150
We do the same calculation as before:
(110 + 120 + 130 + 140 + 150) / 5 =
650 / 5 = 130
What can we use the moving average for?
Normally, I wouldn’t sit and do these calculations by hand every day as we have computers to do this for us.
And we can use these moving averages to get an idea of the general trend of the stock. Of course, we can also see this by just looking at the chart, but the moving average removes some of the noise from the daily swings and gives a more stable picture about whether the trend is up or down.
There are many ways to interpret these average prices. Some traders buy if the price of a stock rises above a certain moving average. Other buy or sell when to moving averages cross each other etc.
What is the disadvantage of this method?
No matter what moving averages you use, then you have to remember that they only describe the past movement. That means, that it is a so-called lagging indicator. Which means, that it will always be a little behind.
That is why you should always be careful to not build your whole strategy on one certain moving average, but you can use it as a form of support/resistance (Link to article).
The most commonly used moving averages
For short-term daytraders and the likes, 10 and 20 period moving averages are widely used. In this case it is not the last 10 or 20 days of data you are looking at, but rather the last 10 price bars, for example 10 x 1 minute or 20 x 5 minute.
So the timescale is different – but the method the same.
On the higher timeframes many use the 20, 50 and 200 daily moving average.
In the videos about this subject you can see much more clearly how the different types of moving averages are calculated and the big variety of use of moving averages in both investing, swingtrading and daytrading.
If you would like to know more about the moving average indicator, then take a look at these two videos describing what a moving average is and how they can be used advantageously.
