How to Use Moving Averages to Buy Stocks?

Moving averages are a powerful and useful concept in trading. It is an integral part of Technical analysis Here is how to use moving averages in intraday and also how to use moving averages to buy stock for delivery. Let us first learn how to trade using moving averages.

How to buy Stocks using Moving Averages

Let us now see how to use the all-important moving averages and understand how to trade using moving averages. Moving averages are popularly abbreviated and expressed just as MA and prefixed based on the type of the moving average considered. Moving averages are extremely popular among day traders, investors, and technical analysts and are an important tool for trading in stocks. What is the purpose of these moving averages? Moving averages on charts help determine direction, strength, trend and also helps the trader to find entry and exit points.

Concept 101, let us start by understanding what are Moving Averages? Remember, that a moving average (MA) is a technical indicator popularly used by chartists and technical analysts. It combines the price points of a given stock over a specified time frame and divides by the number of price points to give a single trend line. Moving averages can be calculated for any sequential data set, but it is most commonly used in the case of price and volumes data based on time series data. You can also extend the moving average analysis to high price, low price, closing price, average price, open price, etc for a more granular view of the market.

How exactly does moving averages or MA help? The moving averages help traders to filter out the unnecessary noise and calculate the average value of a stock price over a specific period, which is more of a realistic average and shows the actual underlying trend of price or volumes. Above all, these, moving averages can help determine the direction of the current trend, while easily and effortlessly offsetting the impact of random price spikes. The very name-moving averages suggest that they move the original price line into a more indicative and trend-rich indicator.

Four key types of moving averages to understand

Here are the 4 important types of moving averages you must be familiar with.

  • The most basic one is the Simple Moving Average (SMA). The SMA is also known as the arithmetic moving average and it is calculated by summing up a selected range of closing prices and dividing the sum by the number of periods in that range. It is easy to execute and simple to understand. While the SMA can help to establish the trend of stock price and whether the price will sustain or reverse; it does not give value-added insights unlike better measures of moving averages available.

  • A more sophisticated version is the Exponential Moving Average (EMA). These exponential moving averages or EMAs are calculated by taking the closing prices of the defined period. However, there is a slight difference. Unlike the SMA which is more time agnostic, the EMA gives more weightage to the more recent price trends and less weight to the older price trends. This is considered to be more reflective of the trend that traders are actually looking at and hence is more actionable. The benefit of EMA is that they react faster to changes in price and hence offer a good high-frequency trading technique. Similar to simple moving averages or SMAs, even EMAs can be easily found in most charting or trading platforms. This is popularly used by most analysts for trading decisions.

  • Weighted Moving Average (WMA) are broadly similar conceptually to the exponential moving average. That is in the sense that weighted moving averages also put less weight on older closing prices and more weight on recent closing prices; exactly the way EMA does. The advantage with WMA is that it is more easily customizable although, for any analytical endeavor, the EMA does a fairly good job of showing the recent high power trend in the price.

  • The most important indicator called the Moving Average Convergence Divergence (MACD) is what you need to understand in detail. Moving average convergence divergence is a common technical indicator and it is entirely based on the concept of moving averages. The MACD measures the strength of a trend and uses two moving average prices and calculates the difference to identify trends. The MACD is the 12-period EMA minus the 26-period EMA, for example.

Why are moving averages important for a trader?

Here is why moving averages are not only important but almost inevitable for traders in cash, futures, and options.

  • Moving averages help to reduce the noise on a price chart, which is another word for the unnecessary and distracting data points. The EMA, WMA, and SMAs help cut down the noise on trading charts by smoothing out the data and creating a smooth trend. This trend may either show short-lived changes in the price of a stock or sustained changes. These averages make it easy to read and detect trends.

  • An important point is that moving averages or MAs can be used to confirm uptrends and downtrends in the stock price. If the price of a stock is higher than the moving average, it implies that the stock is trading higher during the specified period, on an average. On the other hand, if the price of a stock is lower than the moving average, it means that the stock is trading lower during the specified period, on average.

  • Moving averages act as supports or resistances and actually, you can say that they virtually double up as support or resistance lines. For example, 200-day 100-day, or 50-day moving averages may act as support or resistance lines depending on the case in point. A support level is a barrier to price fall, while resistance is a barrier to a price spike.

  • Moving averages are flexible so that can be combined with other indicators to create trade signals. Just a case in point. If a short-term moving average crosses a long-term moving average, it is called the golden cross and is seen as indicative of a major rally.

How to interpret and apply moving averages in your trading

Here is how you can apply moving averages in practice.

  1. You can know the trend of the stock price by plotting a single moving average on your trading chart.

  2. If price action remains above the moving average, this is a sign that the price is in an uptrend and ripe for a buy trade.

  3. When price action seems to remain below the moving average, it is an indication that the price is in a general downtrend and you can consider it ripe for a sell or short trade.

These are just indicative interpretations and you can take them at face value. The trader must apply his / her discretion before taking a final call.

What are Support and Resistance?

The support and resistance levels of stock are both intuitive and technical levels. You can look at them as specific price points on a chart that will attract the maximum amount of buying or selling. The support price is where one can expect more buyers than sellers. Similarly, the resistance price is a price at which you expect more sellers than buyers.

Different Strategies for Online Trading

There are some basic approaches online traders can use with the help of moving averages using Online trading app. For example, if price action remains above the moving average, this is a sign that the price is in an uptrend and ripe for a buy trade. When price action seems to remain below the moving average, it is an indication that the price is in a general downtrend and you can consider it ripe for a sell or short trade.

Frequently Asked Questions Expand All

You can buy or sell the stock based on moving averages based on whether the moving average line is above or below the price line. The moving average line is more representative as it is a smoothened line and gets rid of the noise in the price data.

There is nothing like the best moving average. SMA is very simple and easy to calculate. EMA and WMA are more sophisticated and EMA is a good approximation of giving more weight to recent data.