Moving Averages - 3

I am back. Did not think that I will be able to write again before weekend but God has been kind. So without wasting your time, will continue our Moving Averages tutorial.

In the first two parts we have seen what are MAs and popular types among them. I will resist the urge to get in to other types of MAs as honestly that will just be a general knowledge without any practical use for trading. So as discussed, we will see which duration we should use, which type and why?

Duration:

Most simply put, duration depends on what kind of view you need about the direction of the market. In other terms, if you are looking at short term trend or you are a trader you will use MAs of lowest duration like 5 day, 10 day or 20 day. If you have a horizon of medium terms (few months) you will be more interested in 50 day kind of MA and if you are a long term investor, your choice would be like 100 day or 200 day MA.

200 day EMA is probably the most popular among all. It is a very long duration MA and usually a strong and reliable indicator of trend, change in trend. It also usually is a strong support or resistance. Medium term investor prefer 50 day MA and short term trader 5 or 10 day duration.

Short duration MAs are very agile and they adapt to price very fast. You will see a change in them even with a single day large move. Long term duration MAs are lethargic. They tend to be very smooth and usually do not get affected by short term volatility. See the self explanatory chart.

Type:

Another normal dilemma is which type of MA to use. Simple MA (SMA or DMA) or Exponential (EMA)?

To be fair, none is better than the other. EMAs give more weight-age to recent prices hence quicker to react. SMAs are simple and represent true average of period under consideration. Usually SMAs are more reliable while indicating Supports and Resistance Levels and EMAs give an early indication of change in Trend.

As you can see in above chart, 50 EMA straightens out before 50 SMA as shown in first oval. At second instance also, 50 EMA starts to drop before 50 SMA.

Here I would like to make one thing clear that one should try various duration, types of MAs depending on one's objective, time horizon, investing style and comfort level. As I have mentioned in some earlier post that I am more comfortable with EMAs, similarly you should find out your own preference.

This now leaves one last post (I am not sure if I will be able to cover everything in one post) about how to trade using MAs. I will write more than one post if it becomes too long to cover all of it in one go. Just wishing that I get the time to do so quickly.

Keep the comments flowing.

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