Simple and Exponential Moving Average (Part 2) – Some Ideas!
Some Ideas To Get You Started
You have reached part two of this article and I’m sure you are excited to know what averages can do to help us in taking our investing/trading decisions.
We will not be teaching a full scale methodology here, that will only be seen on Tradeacademy.in with a plethora of other resources for both the trader and investor.
Rather in this article we will look a t a few ideas that you can start building a method over on your own, we are merely listing down some interesting ideas that may help you on your journey to trading mastery.
The SMA and the EMA can be used to get an idea of trend direction. The popular way of doing this is through a cross over system. Essentially a crossover consists of two moving averages, one which is slow say the 50 EMA and one which is fast, say the 21 EMA.
A Bullish Setup using crossovers
1) When stocks are moving down then both averages will slope downwards
2) When the stock moves upwards and the faster average (21 ema) starts crossing upwards and we will have a bull trend confirmation.
Here are 3 examples of this happening, the black line is MA 30 and the blue line is EMA 21.
This is a chart of ICICIBANK on the daily timeframe, notice the month of September. The market was falling and then around the time of Raghuram Rajan’s appointment as RBI governor the market moved up and the moving averages crossed over. This basically meant that the downward momentum has seen a sudden shift away from the mean average to in comparison to the sudden upward rising prices. This is conveyed in visual form as a cross over.
You will see that the faster average, in blue crossed over the black average triggered a new trend upward.
The same principles are also true for an upward trending market to reverse on the downside. As seen in the chart below ICICIBANK on the daily charts reversed it’s direction when the moving averages showed a deviation from it’s regular dataset, as seen visually as the blue line crossing the black line.
Below is a chart of Reliance Capital on a much shorter timeframe, the hourly. You will notice that the movement is much shorter lived, it is a beautiful example of 3 reversals, all of which worked if you had a good exit plan to capture those gains.
Point 1 is where the trend changed upwards
Point 2 was created because of a gap down (deviation from the dataset) and the averages triggered a downtrend reversal. The markets did fall on this occasion
Point 3 was the final reversal which gave a nice prolonged move upwards right after the moving average crossovers gave us a reversal signal.
Long term averages tend to provide the market with support areas and resistance areas. Since market over longer periods of time tend to move upwards the roe of MA as support has long played an important part for investors.
Due to the nature of higher timeframes and longer MA periods these situations come very occasionally. Let us look at some support examples:
This is a chart of Nifty with an orange 250 day simple moving average on it, if you notice that most great falls tend to find support +/-2% of that moving average line. It is far from perfect however since in September that fell right through the moving average without showing it any consequence. It is, to be used as a general guiding light rather than any sort of trigger.
The 200 day MA is also very popular among stocks
Be Careful of Sideways Markets
When doing anything with a perspective of of trending markets, sideways drifts will almost always be a killer. Here is a chart showing just that, moving averages are so slow that they inherently do not have the ability to handle sideways areas. To handle such areas you need a strong methodology like the Newton Method or something similar.
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