Definition of simple moving averages
Basically, they are indicators quite often used in technical analysis, and show the average value of a security's price over a set period of time. They are formulated by computing the average price of a security over a specific number of periods. They are usually based on closing prices. A 10-day average is the 10 day sum of closing prices divided by 10. These averages can be used to measure momentum, analyze the direction of a trend, recognize changes in a trend, and define areas of possible support and resistance. They also help to smooth out price and volume fluctuations.
Developing a trading system
Some traders and investors use simple moving averages to develop a trading system. The system is based on moving average crossovers. It is important to remember that a shorter average moves faster than a longer one. As an example, a 5-day average moves faster than a 15-day average. You would get a buy signal when the shorter, or faster average advances above the longer, or slower average. A sell signal would take place when the shorter average crosses below the longer one.
The speed of the trading system, and the number of signals generated will depend on the length of the simple moving averages. If you have shorter averages, your system will be faster, and give you more signals. It will also generate more false signals than a system with longer, slower averages. Moving averages by their nature, are lagging indicators. This is because they use historical information. They will not get you in at the bottom or out at the top of a major price movement. You will be able to get in and out somewhere in the middle though.
The secret of the 50-day average
When you analyze intermediate and longer-term trends, the 50-day simple moving average is quite reliable. Big players such as mutual funds and hedge funds are most likely to follow this key average. That is the secret of the 50-day average. It is important to watch stocks that regain the 50-day line. This tells you they might be resuming up-trends.
Stocks often pull back to their 50-day average after breakouts. The key is to watch how stocks trade near the 50-day line. An ideal situation would be a stock pulling back to the line in low volume. At that point, you want to see the stock bounce off the line in above-average volume. This is telling you the big players are supporting the stock.
The 200-day is also important
The 200-day simple moving average will give you a bigger picture of a stock, or even an index's trend. It is also useful for identifying longer-term support. The last part of a stock's pattern or base should always be above the 200-day line. You can also use the 200-day line as a selling indicator. If your stock is 100% or more above the 200-day line, it is probably a good idea to sell it. Most winning stocks rarely get above that line.