It doesn’t matter…
But this is the concept behind the Moving Average even if there are a lot of variations to it.
Moving on, you can see that the black line is the 200-period Moving Average:
How not to trade the Moving Average indicator
It’s important to know how to trade an indicator, and how not to trade it, or rather when not to trade it.
Traders would often say…
"Hey! The 20-period Moving Average crossed above the 50!"
"It’s a buy signal!
"Look how profitable a Moving Average cross over is!"
What they don’t show you is that when the market ranges, you’re going to get whipsawed:
And as you know, the market tends to be in a range more than it trends.
However, if you are trading a Moving Average cross over strategy as a discretionary trader…
I don’t suggest it.
Because you’ll tend to lose money in the long run.
However, if you are a systematic trader applying a trend-following approach, then this can work.
But for most of you reading this post, you’re probably a discretionary trader, and this is an approach I won’t suggest.
How to trade the Moving Average as a Trend Filter
Often, I get traders asking me…
“Hey Rayner, should I be buying, or selling?”
What you can do is to use the Moving Average as a trend filter!
It tells you whether you should be buying or selling.
You can see that the black line over here is the 200-day Moving Average:
It doesn’t matter whether you are using exponential, simple, weighted – It doesn’t matter, the concept is what matters.
Right now, the price is above the 200-period Moving Average!
One general guideline is that…
When the price is above the 200-period Moving Average, stay in a long bias.
This means that the market is in a long-term uptrend and you want to be buying in this market condition.
Over here, I can identify a possible area of support where you can look to buy in this market condition:
You can see over here that the price is above the 200 MA:
What should you do?
You should only be looking for buying opportunities in this market condition.
Another way you can use a Moving Average is to trail your stop loss...
How to use the Moving Average as a trailing stop loss
For example, the price has broken and closed below support and you short the break down here:
The price is in your favor and now you want to ride the trend.
How do you do it?
What you do is to use a 20-period Moving Average to ride the short-term trend lower!
There is nothing magical about the 20-period Moving Average.
Often, I get questions from traders, “Hey Rayner, which is the best Moving Average, should I use the 20? 50? 100? 200?”
There is no best.
It really depends on your goal or what you are trying to achieve!
I’ve shared with you the 20-period Moving Average for traders who want to capture a short-term trend.
If you want something that gives your trade room to breathe, you can even use a 50-period Moving Average:
What should strike out to you is that using a 50-period Moving Average gives you more room for your trade to breathe!
You can see that the trade can withstand a deeper pullback:
Whereas the 20-period Moving Average cannot withstand deeper pullbacks:
So, it all boils down to your goal whether you want to capture short, medium, or long-term trends!
And you can use the appropriate Moving Averages to meet your goals.
Another way you can use the Moving Average is to look for Areas of value on your chart.
How to use a Moving Average to look for an area of value
For example, the market is in an uptrend:
And you are wondering, “where is the good time to buy?”
What you can do is to put on the 50-period Moving Average and see if the market tends to respect the Moving Average:
As you can see, the market clearly respects the 50-period Moving Average!
In the future, if the price comes back towards the 50-period Moving Average…
What you can do is you can look to buy!
Because the price is in the area of value.
One simple way to enter the trade is that you can wait for the price closes back above the 50-period Moving Average.
Here are some previous entry triggers:
This is a very simple entry trigger to get on-board the trend if the Moving Average serves as an area of value.
Another example, the price tends to exceed the Moving Average and closes back above it:
The reason why I shared this is that there isn’t the best Moving Average out there.
You should expect that the price would come very close to it and reverse in your direction without you.
So, you have to handle the different situations that come along.
Let’s do a quick recap on how we can use the Moving Average indicator.