MOVING AVERAGES
Moving averages provide the average of the price action over time. There are three types of moving averages:
Simple moving average(SMA)
Linearly weighted moving average(WMA)
Exponential moving average (EMA)
The time period of these averages that most people take into account is 4, 9 and 18 days for day traders and 20, 40, 100 and 200 days for longer term trading.
Select exponential moving average from your charting service. Give the charting package the above values and see the result. You have three moving averages in your chart. Look the figure below. We have a 10 day moving average (blue line), 20 line moving average (pink line) and 40 moving average (green line)
Longer term moving averages especially 100 and 200 days often act as strong resistance or support for the price. Look the figure below and notice how market respected 100 (blue line) and 200 day (pink line) moving averages as support lines.
Looking closer we may notice a head and shoulder pattern evolving and having as neckline the 100 day moving average. Isn’t it beautiful? When you will practice what you will learn in this book a new beautiful world will evolve in front of your eyes in the previously “desert” charts that seemed confusing.
When a shorter period moving average intersects a longer period moving average you may take this into account for a possible trend reversal hint. Look the first figure. The shorter period moving average (blue) intersected pink line (20 day moving average) and then green line (40 day moving average). This signaled that the previous trend changed and this trend reversal continued until the shorter moving average intersected upwards this time the longer moving average at the right end of the figure.
Moving averages are lagging indicators. Price takes action and moving average follows.
Some people are using moving averages extensively and design trading systems based solely on them.