Since I work in the financial industry, I get opportunities to speak to stock brokers and portfolio managers. Each of them have their little secrets (some of them are good, while some of them are very bad! Hahaha!). One of them is called moving average trading.
Market swings are giving you headaches? You don’t want to risk your retirement fund but you want to make more money than 3% with a 5 year certificate of deposit? Have you ever heard of moving average trading?
What is Moving Average Trading?
This is a derivative trading strategy from technical analysis. Moving average trading basically needs 2 data to work:
– A Stock Chart
– The Stock Moving Average
In order to show you how moving average trading works, I’ll take an example. So let’s pull out the 5 year stock chart of SPY, one of the top US Market ETF. While I am using an ETF, you can use the moving average trading technique with any stocks.
ETF 5 Year Stock Chart
Ok… the chart alone doesn’t tell us much about what and when to trade… We can only acknowledge all the ETF fluctuations over the past 5 years. In order to know when we should be trading, we will need the 2nd piece of the puzzle: a 200 day moving average.
ETF 5 Years Stock Chart Along With its 200 Day Moving Average
Just before we analyze the graph…
Let’s take a step back and look at what the moving average represents. The moving average is a statistical concept used to measure major trends in data. The moving average is usually used by technical traders. It helps trigger a buy or a sell action. You can use a moving average with the number of data points you want (10, 20, 30, 50, 100, 200, etc).
Moving Average Example
Lets say that you have 50 data points and you want to calculate the 20 days Moving average. You will take the data from 1 to 20 and make an average. This will be your first point. Then, you will take the data 2 from 21 and make another average. This will be your second point on the graph. You now take data 3 from 22 and so on. Along with your graph from 50 data points, you will also have a smoother line showing the current trend of your data; this is the Moving average.
What is the point of using the moving average while trading?
The moving average will replicate the trend of the stock you are following (the ETF in this example). Therefore, it shows when the stock is on a up trend or a down trend. As you may know already, there is a huge psychological factor on any stock market. Therefore, if you can predict the trend of a stock or an ETF, you will know when it is the best moment to buy or sell. While this sounds pretty magical, it is far more complex than some wishful thinking. However, the moving average added on the stock chart helps you determine what the major trend is.
Wait! How Do We Use Moving Average When Trading?
In an upcoming post (next Monday), I’ll explain how to use the moving average and provide a full example of how you can do it. So stay tuned to know how to use the moving average when trading