Strategies: Moving Averages

In this article I will present one of the technical strategies used by many technical and fundamental traders alike. Moving averages, often abbreviated as MAs, are used as a data smoothing technique and are considered a lagging indicator. Moving averages work by averaging the price fluctuations over a given time frame. The time frame used is referred to as the “period.” Common periods include 14, 50, 100, and 200 period moving averages but these can further be adapted to additional time frames by adjusting the length of one period. In stock trading, the most common length of a period is the day, which means that a 200 period moving average is in this case a 200 day moving average. The 200 day moving average is widely regarded as a very telling indicator in the world of stock trading. In other markets, traders may apply the 200 period moving average to an hourly chart effectively making it a 200 hour moving average. This technique can be used to provide more specific and recent data which can provide a greater, but not necessarily as accurate, number of trades. Obviously this can also be accomplished by leaving the value of the period alone and simply changing the number of periods you are averaging. So for instance, looking at a 50 day moving average on a stock chart will produce a line that is not quite as smooth as a 200 day but provides more recent and relevant information. Further, there are two basic types of moving averages; the simple moving average (SMA) and the exponential moving average (EMA). The simple moving average does exactly what its name implies by simply providing an unweighted average of the previous number of periods specified. SMAs, especially of larger time frames (100+ periods) are often very smooth lines and are rarely touched by the actual price of a security. Exponential moving averages give more weight to more recent periods. For example, a 200 period exponential moving average still uses the previous 200 periods worth of data but assigns different weights to each one. In this example, the most recent 50 periods may receive a weight of 4 while the previous 51-100 periods will receive a weight of 3 and so on. Traders use these values primarily by overlaying a moving average line on their charts and placing trades around these levels. For instance, a stock trader may use the 200 day moving average as a sign to buy a security. If the price of a stock is above the 200 day moving average, a trader will wait for the price to dip down and touch the 200 day moving average and use that as a signal to buy the stock. Moving averages are a very basic but also a very useful indicator to use for first time and experienced traders alike.

CFTC Required Rule 4.41:

Hypothetical or simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been executed, the results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profit or losses similar to those shown.

Hypothetical Performance Disclaimer: 

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.