Moving Averages

Simple and exponential

A simple moving average gives every period the same weight. An exponential moving average weights recent periods more, so it turns faster and hugs price more closely. The 20, 50, 100 and 200-period averages are conventional, and the daily 200 is watched by so many participants that it acts as a level in its own right.

Three uses

• Trend filter: only take longs when price is above the 50 or 200-period average, and shorts when below.
• Dynamic support and resistance: in a trend, pullbacks often stall at the 20 or 50-period average, giving an entry area.
• Crossovers: a faster average crossing above a slower one signals an uptrend, and crossing below a downtrend. The 50 crossing the 200 is the widely reported golden or death cross.

Lag

Every moving average is built from past prices, so it turns after the price does. The longer the period, the smoother the line and the later the signal. Crossovers in particular arrive well after the trend has begun and produce whipsaws in ranges, where the averages cross back and forth. A moving average tells you what has been happening; it cannot tell you what will.

Settings

There are no magic numbers. Pick one short average for the pullback entry and one long average for the trend filter, use the same settings on every chart, and stop changing them. Optimising the period to fit last month's chart produces settings that fit last month's chart.

Key takeaways

• A moving average smooths price into a direction; EMA reacts faster than SMA.
• Use it as a trend filter, a pullback level and, cautiously, a crossover signal.
• It lags, and whipsaws in ranges.
• Fix your settings and leave them.