In this article, you are going to learn a trading strategy using moving averages. I love to use multiple moving averages to get a clear and clean trend. Trading using moving averages is one of the simplest and easiest methods to trade, yet it is powerful enough to make consistent money. This strategy which I am going to explain works in all kinds of markets, be it equity, commodity, currency.
You just need to have the right trading plan to execute this strategy.
So let’s get started with the strategy.
What is moving average
If you are a mathematics student, you should be probably familiar with the term ‘’Moving Average”. It is the average of last n items, so it is calculated by adding up last n numbers and dividing it by n.
For example, if we have 4 numbers 24, 35,45,32 respectively and we are required to calculate the moving average of these 4 numbers then it will be calculated as:
(24+35+45+32) divided by 4 = 136/ 4 = 34
Hence the moving average of the above 4 numbers is 34.
This moving average is called a simple moving average, as we have given equal weightage to all the numbers.
In the stock market generally, more weightage is given to recent prices rather than past prices. If we calculate by assigning weight to a different number then it is called a weighted moving average.
If you have not understood the above concept, don’t despair. We are not supposed to understand how the moving average is calculated; it is explained so that you can understand the nitty-gritty of the moving average.
In trading, we have to understand the practical aspect of moving average, i.e. how to use it to earn money in trading.
Almost all trading software( be it free or paid) provides this facility to enter moving averages. Free trading sites like tradingview.com also provide this under an indicator.
I would like you to not just to read this article, rather open a trading software and do as I am going to do here.
Which moving average to use for trading
This is something that depends on form trader to trader. Some traders love 200 MA(moving average), some love 50 MA.
No doubt they are good moving average as a lot of big players track them, but we will be using three moving average and they are 13 period, 21 period and 34-period exponential moving average.
You might be wondering why these 3 MA.
As of now if you are also sitting in front of your trading software just add them. In the later articles, I will explain why these 3 MA ( just a little hint that these 3 are Fibonacci numbers!!)
Add these 3 exponential moving averages. At this point in time your screen should look like this:
3 ingredients to enter into a trade and earn money
To enter into any trade you should have these 3 ingredients working in your favor:
You might have read in books and websites like moneycontrol.com “ Trend is your friend”. This is a kind of universal truth. If you want to trade you will want to trade in the direction of the trend than trading against the direction.
The big question is how will you find the trend. The three moving averages which we have entered will help us identify the trend.
If we are getting a nice smooth, orderly slope in all the 3 moving averages then we are in good trend, else trend is not good.
We will only look for stocks which are in good trend, either upside or downside.
Look at the image below for trending stock vs nontrending stocks.
Once we have identified the stocks in a trend ( either up or down), we will look for short term against the direction move and wait for momentum to turn in the main direction of the trend.
This can be achieved by using some momentum indicators like RSI or stochastic or William %R.
In trading entry is very important. Once we have identified the trend and identified the momentum, next thing we should do is to enter into that stock. And we can precisely make an entry by using candlesticks. I have explained about 5 important candlesticks pattern, please look at them if you are not aware of them.
Combining it all together
Once we have all the 3 ingredients our recipe for success is ready. Please note that like other strategies this is also not a 100% success strategy and is definitely not a get rich quick strategy. You need to work hard to achieve success.
Let’s look at some of the examples:
I hope you will be able to understand these examples with the help of charts. Please message me if you require any help to understand it.
To trade using moving averages we will use 13,21 and 34 period exponential moving average.
We will have to turn trend, momentum, and entry all in our favour before we enter the trade.
We will identify trends using moving averages. Momentum using some momentum indicator and entry using candlestick pattern.
Once we get a favourable risk reward we will enter into the trade and follow the money management rules.
So traders, thanks for reading this article on moving averages. How is the article? What can be further done to improve it? Your next step is to practice this and do backtesting. Do you have any queries on moving averages? Please ask and comment below.