3 Important Moving Averages

Today, you’ll learn which moving averages are important.

Including:

  • 5 day EMA
  • 10 day EMA
  • 20 day EMA
  • Crossover Strategy

The 3 important moving averages are the EMA5, EMA10, and EMA 20. EMA is an exponential moving average indicator for trading stocks.

Trading stocks may need a technical indicator that can give momentum signals.

Signals can be a crossover of two or three EMA values.

The values are going to be set to reflect the stock’s current price action.

Price action should be close enough to the price to be relevant to the trading strategies.

The strategy below is for swing traders looking for profitable trades.

Profitable trades can be realized if a momentum indicator is used.

A momentum indicator can show the strength or weakness of a stock.

The strength can be measured through moving average indicators.

However, a moving average indicator is a lagging indicator and the signals derived from it is usually not reliable.

To get reliable readings, the settings must reflect the current price actions relative to the past.

The past can be two weeks and one month.

Why do traders use moving averages to trade stocks?

Trading stocks needs some reference to be able to read the context of the price action.

What type of moving average to use?

It is recommended to use the exponential moving average for shorter periods. (source)

Shorter periods are usually below 50 days and in this post, the focus is more on short-term trades.

Since short-term trades only last for a few days up to few months, EMA will be used as the strategy below.

The strategy uses a crossover from one EMA to another EMA to confirm the momentum of the trend.

The trend to look for in this strategy is only uptrend.

In an uptrend, the trader needs to buy and sell only and shorting is not recommended here.

Although shorting may work in this strategy, it is not recommended.

The advice is to only buy when there is an uptrend and do nothing when there is none.

Doing nothing is also a good strategy to reduce trading losses.

To lessen the losses, traders need indicators that react faster with price action.

The indicator to use in this strategy is the Exponential Moving average.

EMA is important because it can detect short-term correction of an uptrend.

A correction happens when the price moves down from an uptrend.

The move may give traders a buying opportunity and they can follow the trend.

However, how can they know that it is time to get into the stock?

5 Day EMA

The 5 day EMA is the exponential moving average of one week trading days.

One week trading days are used to understand the latest price action.

The latest price action is important to short-term traders so that they can react faster to price movements.

Reacting faster to traders means an opportunity to make money.

However, there is one problem with using only the 5 day EMA indicator.

The indicator may give a lot of false momentum signals on its own.

Signals are less reliable because of the short-term volatility.

Because of the volatility, traders often do not use the 5 day EMA alone for their trading decisions.

Their decisions may come from crossover below to a higher period EMA.

Crossovers are commonly used in most moving average trading strategies.

In this trading strategy, 5 and 20 EMA is important to get momentum signals.

However, a filter is used to increase the probability of a profitable trade.

The trade will be made when all the conditions are met after a sharp correction.

10 Day EMA

The 10 Day EMA represents two weeks of trading. Two weeks moving average is a filter to increase the winning rate of the trading strategy below.

Well, the strategy may need to have a sharp correction from an uptrend to have high probability trades.

High probability trades often come from a sharp downward move and then taking stock positions to follow the upward move.

The sharp downward move is detected when the 10 EMA is above the 5 day EMA.

Also, if the 10 days EMA is below the 20 EMA, there must be a strong downward move from the uptrend.

A strong downward move is needed to detect a possible continuation of the stock price upward.

Why it is needed?

It is needed because a bearish momentum followed by bullish momentum is a reversal signal.

A bullish reversal signal often makes the stock price to continue moving up.

The continuation happens because the sentiments of traders are mostly long.

Traders may use the 10 EMA to filter stocks that are temporarily bearish.

20 Day EMA

The 20 day EMA represents the average of one month of trading.

One month is a longer period and the indicator is slower to react to the stock’s price action.

The price action can be understood by comparing 20 EMA with the 5 EMA.

In technical analysis, a crossover of 5 EMA to a higher period EMA is considered a bullish signal.

Of course, the signal must be filtered with the 10 EMA to include the sharp downward move followed by a recovery.

The recovery is often considered as a buy opportunity.

However, the opportunity must also be supported with good average volume or some candle sticks patterns.

The average volume must be enough to be able to enter and exit trades easily.

What is enough depends upon the trader’s capital or trade size.

For example, if the trade size is $1,000,000, the volume times market price must be at least $25,000,000.

This will allow traders to be in and out the stock fast and without problems.

Crossover Strategy

Buy Strategy:

  • 5 EMA crosses from below the 20 EMA
  • 20 EMA must be above 10 EMA.

Sell strategy is not discussed in this post. The trader needs to study the exit signals.

_SECTION_BEGIN("Price");
SetChartOptions(0,chartShowArrows|chartShowDates);
_N(Title = StrFormat("{{NAME}} - {{INTERVAL}} {{DATE}} Open %g, Hi %g, Lo %g, Close %g (%.1f%%) {{VALUES}}", O, H, L, C, SelectedValue( ROC( C, 1 ) ) ));
Plot( C, "Close", ParamColor("Color", colorDefault ), styleNoTitle | ParamStyle("Style") | GetPriceStyle() ); 
_SECTION_END();

Plot(EMA(Close,5),"EMA5",colorRed,styleLine);
Plot(EMA(Close,10),"EMA10",colorblue,styleLine);
Plot(EMA(Close,20),"EMA20",colorgreen,styleLine);

//this will buy when the EMA5 cross from below ema 20 and sell when EMA 5 cross from above
//EMA 10. Buy signal is triggered if EMA20 >EMA 10 at the cross of EMA5 to EMA 20
//Exploration
filter=Cross(EMA(Close,5),EMA(Close,20)) AND EMA(Close,20)>EMA(Close,10);


//indicator
bsignal=Cross(EMA(Close,5),EMA(Close,20)) AND EMA(Close,20)>EMA(Close,10);
ssignal=Cross(EMA(Close,10),EMA(Close,5));
//=bsignal;
//Sell=ssignal;
Buy = ExRem(bsignal,ssignal);
Sell = ExRem(ssignal,bsignal);
PlotShapes(shapeUpArrow*Buy,colorGreen,0, L,-20 );
PlotShapes(shapeDownArrow*Sell,colorRed,0, H,-20 );

The above Amibroker AFL Code maybe used to detect these kinds of stock price action.

In this price action, there is a clear signal because the bearish move is immediately followed by a bullish move.

The chart above is an example of this strategy. The strategy shows that the stock rallied after the first buy signal.

Also, the next buy signal may be successful.

However, to be successful in this strategy, there must a established uptrend.

Bonus

Investing.com provides this data by typing a stock symbol and then click through Technical and then Technical Analysis.