The Moving Average Indicator: Trader's Friend In Trending Market
What Is Moving Average?
In simple language, it is a technical indicator which smooths the price flactuations over a few days or weeks of a stock price. It calculate the average price over a specific period like 20 days or 200 days and plot as a line in chart.
Types Of Moving Average
Simple Moving Average:
This is the most basics moving average where you calculate the average of closig price of a perticular period. Simple moving average is a lagging indicator compare to exponential moving average.
Exponential Moving Average:
This assigns more weight to recent prices, and making it more reactive to current trend. It it has more weight in current price it provide faster singnal than the simple moving average.
What Is The Conventional Use Movign Average?
There are many conventional ways to use moving average but has less validity in trading. People try to identify trend using MA, but I believe, for trend identification top down method is the best way. Normally MA rising mean trend is up is a very bad concept. MA may rise both in up and down trend.
Some people use MA to identify support and resistance. You can plot MA below the price chart in an up trend and can plot MA above the price chart in a down trend. While price is in up trend and fall near to the a specific MA line, people believe that area may act as a support and opposite is also true. When price rising in a down trend and rich near around the moving average slope, is consider that price has riched the resistance.
People use moving average crossover a long trade signal, while shorter period MA gives positive crossover with longer period MA, people consider as a buying signal, and oppositely when higher time period MA crosses down over the lower time frame MA traders get a selling signal.
When To Use Moving Average?
Moving average works best in a trending market only, mean when up or down trend is very clear that time only MA can smooth out short term noice and able to highlight underlying trend.
Always avoid using moving average in choppy market, during this time MA generate excessive trading signal and you may fell in to a trap. Almost every trade will stopped out.
Use Of Moving Average (20, 100 & 200 DMA)
Use of 20 SMA:
There are many traders who placed 20 SMA (Simple Moving Average) or 20 EMA (Exponential Movign Average) on their chart. When price close consicutively second time avove the 20MA they buy it and continue to hold it untill price close below that 20MA line for the second time.
Look at the picture right side, the accuracy of MA is very less in this type of trade. Right side picture is Nifty's Daily chart several times price has rise above and fall below the MA line, only once it has given a perfect return. The reason behind the return is that time price was rising from Nifty's weekly demand zone. 2nd Picture is Nifty Weekly demand Zone.
This trading strategy is effective only after this types of scenario, when price appraoch a weekly or monthly demand and then rising above 20 DMA and close for the second time, is the best time to use 20DMA.
26th Oct Nifty approached weekly demand, 7th Nov closed second time above 20 DMA
Nifty approached weekly demand zone on 26th Oct2023
Nifty daily: 3 big rally where 10 zigjag movements, very less traders able to maximize that 3 rally but most of them fall in trap. Even after approaching monthly or weekly demand price fail several times to give a big rally.
This is the drawback of using 100 or 200 DMA
Use Of 100 or 200 DMA
There are amny traders who trades using 100 and 200 DMA. After a long down trend if price starts rising and trade above 100 DMA at least for a week, they consider that price is now officially up trend. Some trader use it 200 DMA.
Opositile when price fall below 100DMA after a longer term up trend, traders believe price has so much weakness and may fall further. So they plan to exit their existing long positions.
An investor can use this strategy but a trader must avoid, in a volatile market several times it generate buy and sell signals and a traders losses money.
No one knows, when market will be trending, so holding a long or short position after 100DMA or 200 DMA is very tough, mean maximizing return is very tough, many traders unable to keep patience and exit with small profit and looses money in several trades.
The ultimate outcomes of trading with MA ended up with a loss in acccount.
Golden Crossover Trading Strategy
There is another popular trading strategy with moving average is called Golden Crossover trading strategy. Normally when a lower timeframe moving average crosses over a highr time frame MA is called golden crossover of moving average.
Different traders uses different combinations.
Day traders uses 4 & 9 or 5 & 13 where second one is more reliable and first one generate faster signal.
Swing Traders uses 13 & 30 or 12 & 26 DEMA
They buy after the golden crossover and sell after the golden crossdown, see the picturs below.
Golden crossover of 13 & 30 DMA, 13 is marked with white and 30 is market with red color
Golden crossdown of 13 & 30 DEMA,
What I use Personally for trading
I use moving average with the context of demand and supply. Once price creates a demand with some big candle I convert my chart into lower timeframe, and then placed 13 and 30 EMA on chart after the big rally or demand. Now I wait, once the golden crossover done and price close first time I enter into that trade. See the picture below, on the left it is a Daily chart of COCHINSHIP, 14th and 15th Mar 2024 it has made two big candle rally, I have converted my chart into hourly (right side picture).
On 1st April 2024 I found the crossover around 10:00 a.m. in the morning and entered into the trade around 898, withi a month it has reached 1378.
