10 Things Traders Need to Know about Moving Averages.

By New Trader
12th Jan 2013

Do you use moving averages in your trading? If not you are missing out on a very simple tool for finding support and resistance levels along with possible trend identification. It is very interesting to lay a 50 day and 200 day simple moving averages on to a chart for the past year. You will begin to see patterns develop. Bounce off the 50 day, a last chance for support at the 200 day etc. Each stock and ETF has different key moving averages and different reactions to them on the chart. It can really help your trading to know the key moving averages for what you are trading and clues to support and resistance, they give clues as to where the buyers and sellers are waiting.

Ten things traders need to know about moving averages.

Cup with Handle (Continuation)

By StockCharts.com

The Cup with Handle is a bullish continuation pattern that marks a consolidation period followed by a breakout. It was developed by William O'Neil and introduced in his 1988 book, How to Make Money in Stocks.

As its name implies, there are two parts to the pattern: the cup and the handle. The cup forms after an advance and looks like a bowl or rounding bottom. As the cup is completed, a trading range develops on the right hand side and the handle is formed. A subsequent breakout from the handle's trading range signals a continuation of the prior advance.

Technical Analysis - Stochastic Oscillator

By StockCharts.com


Introduction

Developed by George C. Lane in the late 1950s, the Stochastic Oscillator is a momentum indicator that shows the location of the close relative to the high-low range over a set number of periods. According to an interview with Lane, the Stochastic Oscillator "doesn't follow price, it doesn't follow volume or anything like that. It follows the speed or the momentum of price. As a rule, the momentum changes direction before price." As such, bullish and bearish divergences in the Stochastic Oscillator can be used to foreshadow reversals. This was the first, and most important, signal that Lane identified. Lane also used this oscillator to identify bull and bear set-ups to anticipate a future reversal. Because the Stochastic Oscillator is range bound, is also useful for identifying overbought and oversold levels.

Technical Analysis - MACD-Histogram

By StockCharts.com

Introduction

Developed by Thomas Aspray in 1986, the MACD-Histogram measures the distance between MACD and its signal line (the 9-day EMA of MACD). Like MACD, the MACD-Histogram is also an oscillator that fluctuates above and below the zero line. Aspray developed the MACD-Histogram to anticipate signal line crossovers in MACD. Because MACD uses moving averages and moving averages lag price, signal line crossovers can come late and affect the reward-to-risk ratio of a trade. Bullish or bearish divergences in the MACD-Histogram can alert chartists to an imminent signal line crossover in MACD. 

Technical Analysis - Relative Strength Index (RSI)

By StockCharts.com


Introduction

Developed J. Welles Wilder, the Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. RSI oscillates between zero and 100. Traditionally, and according to Wilder, RSI is considered overbought when above 70 and oversold when below 30. Signals can also be generated by looking for divergences, failure swings and centerline crossovers. RSI can also be used to identify the general trend.

RSI is an extremely popular momentum indicator that has been featured in a number of articles, interviews and books over the years. In particular, Constance Brown's book, Technical Analysis for the Trading Professional, features the concept of bull market and bear market ranges for RSI. Andrew Cardwell, Brown's RSI mentor, introduced positive and negative reversals for RSI. In addition, Cardwell turned the notion of divergence, literally and figuratively, on its head.

Wilder features RSI in his 1978 book, New Concepts in Technical Trading Systems. This book also includes the Parabolic SAR, Average True Range and the Directional Movement Concept (ADX). Despite being developed before the computer age, Wilder's indicators have stood the test of time and remain extremely popular.

Technical Analysis - Moving Averages - Simple (SMA) and Exponential (EMA)

By StockCharts.com


Introduction

Moving averages smooth the price data to form a trend following indicator. They do not predict price direction, but rather define the current direction with a lag. Moving averages lag because they are based on past prices. Despite this lag, moving averages help smooth price action and filter out the noise. They also form the building blocks for many other technical indicators and overlays, such as Bollinger Bands, MACD and the McClellan Oscillator. The two most popular types of moving averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). These moving averages can be used to identify the direction of the trend or define potential support and resistance levels.

Here's a chart with both an SMA and an EMA on it:

 

Technical Analysis - Bollinger Bands

By StockCharts.com

Introduction

Developed by John Bollinger, Bollinger Bands® are volatility bands placed above and below a moving average. Volatility is based on the standard deviation, which changes as volatility increases and decreases. The bands automatically widen when volatility increases and narrow when volatility decreases. This dynamic nature of Bollinger Bands also means they can be used on different securities with the standard settings. For signals, Bollinger Bands can be used to identify M-Tops and W-Bottoms or to determine the strength of the trend.

Note: Bollinger Bands® is a registered trademark of John Bollinger.

Technical Analysis - Moving Average Convergence-Divergence (MACD)

By StockCharts.com

Introduction

Developed by Gerald Appel in the late seventies, the Moving Average Convergence-Divergence (MACD) indicator is one of the simplest and most effective momentum indicators available. The MACD turns two trend-following indicators, moving averages, into a momentum oscillator by subtracting the longer moving average from the shorter moving average. As a result, the MACD offers the best of both worlds: trend following and momentum. The MACD fluctuates above and below the zero line as the moving averages converge, cross and diverge. Traders can look for signal line crossovers, center-line crossovers and divergences to generate signals. Because the MACD is unbounded, it is not particularly useful for identifying overbought and oversold levels.

Note: MACD can be pronounced as either "MAC-DEE" or "M-A-C-D".

Here is an example chart with the MACD indicator in the lower panel: