Since Stan Weinstein’s book Secrets For Profiting in Bull and Bear Markets, moving averages have become more popular. There are also more choices as technical traders are looking for the best rolling average for determining the market direction. The question is what moving average is the best to use? The question needs to be answered both in terms of type and time frame.
I have studied econometrics and mathematical modeling at a graduate level and applied it successfully stock trading as a broker, analyst and trader professionally and on my own account. Technical trading does work, but only if you keep it simple.
All the theory I learned in school, or a theoretical trading system is not the same as real experience in the stock or currency market. The following is what I have learned. This post does not ramble like many websites on charting and trend analysis. They give your lots of information about double confirmation and resistance and support then concludes with some ‘it depends’ answer. I have a strong recommendation as to what is the best moving average to use for trading stocks or any investment based on my personal experience.
Choices for moving averages
- Simple moving average – My favorite for simplicity and availability. Every major stock or trading website calculates this SMA. It is very convenient and wide accessibility. Every time period is equal in weight. That means if it is a 50 day SMA, then the price 50 days ago is as important as last night’s close price.
- Weighted moving average – The WMA is like the SMA but values days closer to today are more important than prices in the past. This makes logical sense. However, I in my opinion the whole point of an average price is to remove the current noise and get the big picture. History is often more important than yesterday in terms of predicting the future. A smoothing indicator should cut out the current noise. Therefore, I do not use a WMA.
- Cumulative or CMA and Exponential or EMA are all variations of the above. Different ways of slicing the price data.
- Bollinger bands – putting a band around the moving average so a price can trade in a range. I do not like it as it complicates the basic idea. Is the stock or investment breaking out or not. I guess my objection is more a philosophy than a statistical fact.
If you are into calculations and have a nice trading program than use the one you find most useful. However, I would choose one and use it as the primary tool for analysing price. As technical indicators are just tools to help you make selling decisions. Having too many tools are like an electritian with everything in his toolbox, but can not find the thing he needs when he needs it. It is better to have one or two technical tools to pull out that work. Basically you want a moving average to do the job fast and simple and without the clutter or complications. This is why I think the best moving average to use is the SMA.
This is why I recommend you use a basic moving average that can be found on MSN money technical charts.
What is the best time horizon for a moving average?
- Day trading – you will lose your money
- 50 day – this is too short
- 200 day – this is good and recommended by Stan Weinstein, however, for me it gives too many false signals
- 12 month moving average – This is the best time frame for a MA – If a stock price breaks this you know it is in a downward trend.
In my article how to make money in stocks – I give some examples the 12 month simple moving average in use. This 12 month SMA is the best technical indicator for trading in the volatile financial markets.