How to use Moving Averages in stock market

How to use Moving Averages in stock market

A moving average is a technical analysis method that produces a single trend line by dividing the price point of an asset, such as a share, using the number of price points. Many traders have basic query on how to use moving averages, because moving averages are simple to compute for any data set, including share starting and closing prices, trading volume, and a variety of other indicators, they are well-known to be beneficial to all traders.

Most traders use an extended form of moving averages when making selections about which stocks to purchase and sell. To help them decide, traders might use a 20-minute time period, a 5-day moving average, and a 50-day moving average.

What are Moving Averages?

Moving averages (or MAs) are simple but impressive technical indicators that display the average price of a stock over a given time period. On the price chart, they take the form of smooth lines that reflect the average price movement. Moving averages are used by traders to examine the trend of a stock and make informed buying and selling choices. Moving averages can be calculated over a wide range of timescales, making them useful for both long-term and short-term traders that includes intraday trading

Now, the regular moving average is calculated by computing the sum of the closing price of a specific specific time frame and dividing it by the number of periods in that time frame. In other words, the 50-day moving average computes the sum of the closing price of an asset of the last 50 trading sessions, which is then divided by the number 50. On a 1-minute chart—which is more suitable for intraday trading that same 50-day moving average becomes a 50-minute moving average, which is appropriate for intraday trading. 

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Table of Content

  1. What are Moving Averages?
  2. How to use Moving Averages for Intraday Trading to Buy Stocks? 
  3. Why should you use Moving Averages for Intraday Trading?
  4. Types of Moving Average
  5. What does a Moving Average indicate?
  6. What are Moving Averages used for?
  7. What are the limitations of the Moving Average Strategy?

How to use Moving Averages for Intraday Trading to Buy Stocks? 

Moving averages are most commonly used in intraday trading to determine potential entry points. There are two chief moving average strategies for intraday stocks buying:  

1 -  Buy at the Moving Average Crossover

Intraday traders can use moving average crossovers to identify buying opportunities. Two common crossover strategies are:

Price Crossover: Traders buy the stock when the price crosses above the moving average line, regardless of the duration of the moving average. This suggests a possible upward trend. 

Golden Cross: This strategy involves using two different moving averages, such as the 50-day and 200-day moving averages—it would be 50-minute and 200-minute moving day averages on a 1-minute candlestick chart. When the shorter-term moving average crosses above the longer-term moving average, it signals a buy opportunity. This crossover is known as the golden cross and hints at a strong uptrend. 

By buying a stock after a moving average crossover, traders aim to enter at the start of a potential uptrend.

2 -  Buy at the Moving Averages Support

Now, suppose you miss buying the stock at the golden crossover, you may still get an opportunity to buy the stock referring to the moving averages. That is because moving averages act like support levels and operate as demand levels where buyers are likely to enter.  

The stock price generally trades above the moving average line during an upswing; however, minor price drops or deviations occur within the larger rising trend. In such scenarios, it is likely that the price is to recover as it approaches the moving average line. Buying at these support levels can provide intraday traders more chances to build positions.

Why should you use Moving Averages for Intraday Trading?

Here are some of the reasons why you should use moving averages for intraday trading:

  • Noise Reduction: Moving averages aid in filtering out market noise, offering a clearer depiction of the price trend in intraday trading setups.
  • Trend Identification: Observation of the angle and position of the moving average enables traders to determine the stock's trend direction.
  • Profitable Strategy: Trading in line with the identified trend is often considered a profitable approach in trading.
  • Uptrend Indication: An upward angle of the moving average with the price trading above it signifies an uptrend.
  • Downtrend Indication: A downward angle of the moving average with the price trading below it suggests a downtrend.
  • Sideways Trend Indication: Frequent price movements above and below the moving average line indicate a sideways trend.

Types of Moving Average

Here are the two types of moving averages:

Simple Moving Average (SMA): By adding up and dividing five daily prices, one can easily calculate the moving average using the Simple Moving Average (SMA) approach. It generates a single, flowing line by joining each moving average to the previous one and developing a new daily average.

Exponential Moving Average (EMA): An instrument used in stock trading for making choices about stock purchases is the exponential moving average (EMA), which compares weights against current prices. When paired with the standard moving average (SMA), its accuracy and responsiveness to price fluctuations are enhanced by additional weighting based on current price data. Buying shares is done with this strategy.

Example of Moving Averages:  - H2

Depending on the type, the moving average is computed differently (EMA vs. SMA). Here, we examine a security's simple moving average (SMA) for 15 days with the closing prices as follows:

Week 1 - 5 days: 20, 22, 24, 25, 23

Week 2 - 5 days: 26, 28, 26, 29, 27

Week 3 - 5 days: 28, 30, 27, 29, 28

The first data point would be the closing prices for the first ten days, averaged by a 10-day moving average. The price on day 11 would be added, the earliest price would be subtracted, and the average would be calculated.

What does a Moving Average indicate?

The average change in a data series over time by a statistical method called a moving average. Technical analysts in the financial industry frequently utilise moving averages to monitor price patterns for certain assets. A moving average's upward trend might indicate an increase in the price or momentum of an asset, whilst a downward trend would be observed as a drop.

What are Moving Averages used for?

Technical analysis, a subset of investing that aims to comprehend and capitalise on the price movement patterns of stocks and indexes, makes extensive use of moving averages. Technical analysts typically use moving averages to determine whether a security is experiencing a change in momentum, such as when there is an abrupt decline in the price of the asset. In other instances, they will verify their assumptions that a shift may occur using moving averages.

What are the limitations of the Moving Average Strategy?

While moving averages are useful, it's essential to consider their limitations:

  • Lagging Indicator: Moving averages are calculated based on historical data, primarily past closing prices. This lagging nature means that the signals may not be precise enough for some traders. By the time a crossover or support level is identified, the uptrend is already in motion. Some traders use moving averages as trend confirmation rather than relying solely on them for entry points. 
  • False Signals: It's vital to understand that past price patterns do not guarantee future behaviour in the stock market. While a stock may have successfully bounced off a moving average support in the past, there is no guarantee that the behaviour will continue indefinitely. Supports break, resulting in a downward trend even after appearing to hold. Similarly, false crossovers can occur, leading to potential losses.

Conclusion 
Ultimately, moving averages can be a beneficial tool for intraday traders trying to buy stocks in the direction of the trend. Traders can improve their odds of opening positions at favourable prices by using tactics such as moving average crossovers and spotting support levels on their share market app

However, it is critical to recognize the strategy's limitations, which include the lagging nature of moving averages and the possibility of deceptive signals. To enhance trading decisions, it is advisable to choose the right moving average setting and them with other technical indicators and risk management strategies. 
 

Moving Average for Intraday FAQs

No, there is no best moving average and the choice of a moving average for intraday trading depends on the trader's preferences. Some traders may use shorter-term moving averages like 10 or 20 periods, while others may prefer longer-term moving averages like 50 or 100 periods.

Yes, you can use moving averages for identifying potential exit points in intraday trading. For example, you could consider selling the price crosses below the moving average

For intraday trading, you can use moving averages like the simple moving averages (SMA) and the exponential moving averages (EMA). 

Yes, moving averages are frequently used in conjunction with other technical indicators such as the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and Bollinger Bands to confirm signals and improve trading decisions.

No, applying a moving average to your trading screen is not a must, however, the indicator is used frequently since it is easy to interpret.