Rediscover The Basics
Finding Low-Risk Entry Points by Danish Kapur
Sometimes you have to go back to the basics, especially when
you hit a rut. One of the most basic technical indicators you
can go back to is the moving average. It works well in trending
markets but it also has its shortcomings. Here’s how you can
use it to your advantage.
Several myths are tied to the use of moving averages.
Here, I will try to simplify the implementation of moving
averages and clarify some of the more popular myths
associated with them. Moving averages are one of the simplest
tools available to a trader, and they can be of great help
in identifying potential low-risk entry points. But you can’t take them for granted.
There are different types of moving averages such as the
simple moving average (SMA), exponential moving average
(EMA), and weighted moving average (WMA). I will focus
on the SMA, which is the arithmetic average of prices over a
specified period of time.
Moving averages are helpful in determining the direction of a
trend, but if a market is in a trading range, you are better off
using another type of indicator. In addition, there is no “one size
fits all” parameter to use for moving averages. You may find
the 50-day SMA works well for one stock but not for another.
Different moving averages work for different markets and you need to do your due diligence when
it comes to determining which SMA
to use. Discretionary traders can do
this by applying the SMA to a chart
and checking to see how well prices
respect that specific moving average.
System traders can determine how
well the SMA performs by backtesting
and analyzing its performance.