Many traders start with the classic “fast crosses slow” strategy for moving averages—buy when the fast moving average crosses above the slow one, and vice versa. However, as our technical expert, Garrett, explains in the video above, this simplistic approach often leads to losses. Instead, moving averages are best used as a context tool to understand market trends and cycles.
Why Moving Averages Matter
A moving average smooths out price data by calculating the average closing price over a specific number of periods (the lookback period). This simple statistical measure tells you the typical closing price over a chosen timeframe:
- Longer Lookback Periods (e.g., 21-day on a daily chart) help you see the overall, or monthly, trend.
- Shorter Lookback Periods (e.g., 5-day) provide insight into week-to-week price action.
The key takeaway is: moving averages help you identify whether prices are generally rising, falling, or moving sideways. They aren’t magic entry/exit signals but a way to gauge market context and stay aligned with the prevailing trend.
The Right Types for the Job
There are a few types of moving averages that traders commonly use:
- Simple Moving Average (SMA):
The most intuitive version, calculating the straight average of closing prices. - Exponential Moving Average (EMA):
More responsive than the SMA because it gives extra weight to recent prices—ideal for fast-moving markets. - Wilder’s Moving Average:
Uses a smoothing formula that makes it less reactive, which can help filter out market noise.
Garrett prefers the EMA for its balance of smoothness and responsiveness, but the important thing is to pick one and stay consistent.
Using Multiple Time Frames
One of the most powerful strategies is to use moving averages across different time frames. Here’s how:
- Daily Chart:
- A 21-day moving average reflects about a month of trading.
- A 5-day moving average shows weekly trends.
- Translating to Lower Time Frames:
Adjust the lookback period based on the number of bars in your chart:- On a 5-minute chart, use a 78-period moving average to represent one day (since 390 minutes ÷ 5 = 78).
- On a 15-minute chart, a 130-period moving average can represent one week.
- For a 65-minute chart (which divides a trading day evenly), a 126-period moving average reflects one month.
This multi-timeframe approach allows you to “zoom in” on price action and see the same trend dynamics at different levels of resolution. It helps in identifying the strongest stocks to trade and aligning your strategy with the market’s overall direction.
Suggested Books for Deeper Insight
For those looking to expand their understanding of market trends and cycle analysis, here are two must-read books:
- “Secrets for Profiting in Bull and Bear Markets” by Stan Weinstein
Weinstein’s classic work explains market stage analysis and how long-term trends shape price action. - “Technical Analysis Using Multiple Time Frames” by Brian Shannon
Shannon’s approach emphasizes the importance of analyzing trends on various time frames to make smarter trading decisions.
Final Thoughts
Moving averages aren’t a get-rich-quick trading signal; they’re a powerful way to build context into your trading strategy. By understanding the trend on multiple time frames and choosing the right moving average type for your style, you can align your trades with the market’s “path of least resistance.” Watch the video above for a more detailed walkthrough, and consider the suggested books to dive deeper into mastering the market cycles.