Profiting From Moving Averages

| September 30, 2009 | 0 Comments

Moving averages, maybe you’ve heard about them.  Maybe you haven’t.

If you have heard of them, stick around.  I’m going to show you a few simple tools to make your trading more profitable.  If you haven’t heard of them, study this article.  It’ll make a huge difference in how you look at the markets.

Moving averages are a technical analysis tool every trader and investor should have in their toolbox.  Why?  Because they’ll assist you in making better trading decisions.  And better trading decisions mean more money in your pocket.  (And that’s always a good thing.)

Many professional traders use moving averages every day.  These tools guide them to perfect buying and selling situations.

I know some of you are thinking… What’s a moving average?

It’s a technical indicator showing the average price of a stock over a specific period of time.  They smooth out price fluctuations on a chart and they’re very useful for identifying the general trend of the market.

A moving average (MA) can be set up for any time period you like. If you’re a short term trader, a 5-day or 20-day MA would be useful to you.  A long term investor might prefer to watch the 50- or 200- day MA.

Calculating a MA on a chart is complex.  We won’t get into that here.  Just know most websites and charting programs will do it for you automatically.

There’s hundreds of different ways to use moving averages.

I’m going to show you a simple way to use moving averages to your advantage.

Institutions and traders watch the 200-day MA as a general indication of the long term trend.  If the market is trading above the 200-day MA, it’s considered a bull market.  If the market is below the 200-day MA, it’s considered to be a bear market.

The 200-day MA can be used as a buy and sell point for low risk trades.

Let me show you what I mean…

You’ll see the S&P 500 SPDRs (SPY) ETF. The S&P 500 is a benchmark index representing the American economy.  The Standard and Poor’s 500 Index is the most widely followed index of large-cap American stocks.  It tracks the movement of 500 of the largest US companies.

The dark line is the actual price of SPY.  The smooth gray line is the 200-day MA.  In the first half of the chart, you can see the 200- day MA is sloping up.  This indicates that the long term trend of SPY is up.

Find the blue circles in the chart.  Every time the SPY falls to the 200-day MA, it shoots back up. This is because institutional traders (amongst others) are using it as a low risk buy point.

In an uptrend, you want to ‘buy the dips’.  That means buy ‘weakness’ at a low risk buy point.

Let’s go a little further…

Take a look to right side of the chart.  Notice how at the beginning of 2008 the gray 200-day MA starts sloping down.  This indicates the market is entering a downtrend.

In a downtrend, you want to sell ‘strength’.  That means you want to be selling at low risk sell points.  You can see from the red circle the 200-day MA gives us a nice low risk sell point.  Aggressive traders use this as a point to short stocks or buy put options.

This is one of the most effective ways to utilize the moving average.  We’re using it as a buy point in an up-trending market. We’re using it as a sell point in a down-trending market.

Add the 200-day MA to your charts.  It’ll help you identify the overall trend of the market and find low risk buy and sell points.

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Category: Technical Analysis

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