Political Economy

Best moving average

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.

best moving average
What is the best moving average to use? – I have one clear answer.

All the theory I learned in school or a theoretical trading system is not the same as a 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 you 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 the 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 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 of a philosophy than a statistical fact.

If you are into calculations and have a nice trading program then use the one you find most useful. However, I would choose one and use it as the primary tool for analyzing price. As technical indicators are just tools to help you make selling decisions. Having too many tools are like an electrician 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 an 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 of the 12 months simple moving average in use. This 12 month SMA is the best technical indicator for trading in the volatile financial markets.

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Mark Biernat

This is my Youtube Channel: EconLessons

Comments

9 responses to “Best moving average”

  1. maurice

    What do you think about Alexander Elder and how he uses the EMA and MACD as technical indicators?

    Reply
    1. Mark Biernat

      Elder is a smart guy, however, he is not my personal style in terms of trading only because he focuses on a shorter run than I do. That is not to say it is not good, it is, he is rich, it is just not my focus.
      He uses trends to discover potential stock price movement but also an oscillator to look at short-term over bought and over sold positions to get the best price.
      So he might look at the weekly but also daily trend. That is the style of a trader. I am more of an investor who is looking at the 12 month moving average.
      I think reading is book is very positive and you will learn something from it.
      EMA and MACD, are bot good. I use to use them and was enchanted with them for a while, but went back to SMA as I just felt I know it better. I made a point of finding one or two tools, it almost does not matter which one and becoming really good with those, because when you come down to it many technical indicators are trying to give the same message.

      For example lets compare a simple moving average with a moving average with a lag or a smoothing function to it, it does not matter as you become familiar with charts, your brain will start to see the relationship between time and price movement anyway, even if you smooth it or not.

      Reply
      1. Mark

        How do you if know Dr. Elder is rich?

        Reply
        1. Mark Biernat

          I do not know if he is super rich, however, I think he has done well as implied in his stock trading book. I should do more research on him.

          Reply
  2. maurice

    finance.yahoo.com/news/Market-stalls-but-investors-rb-1314472618.html

    Market seems to be losing steam but not a panic.

    Reply
    1. Mark Biernat

      When I was setting up Bloomberg investment information systems in NYC I got into an argument with one of the Bloomberg guys. They said investment information in the form of news was very important.
      I disagreed.
      News and headlines are fun to watch but I rarely make investment decisions based on it. In fact there was one study that correlated negative news headlines with a positive markets. This was because markets are expectational and much of the bad news is already factored into the market. And certainly the little investors like me, do not get the news first.

      I do think there is no robust recovery underway as manifest by the weak labor market and the housing market has a huge inventory of homes for sale and the debt issue, private, state and federal has not been responsibly addressed. But I think everyone knows this and the market has been trending carefully.

      Therefore, I am stick to my guns and watch the moving average on the market as a whole and the tendline. For me this is real news. If I see a reversal of the market trend then I start to pull out of the market.
      The risk with this investment strategy is you can lose some while the market goes through a turning point.
      However, if your individual picks are strong based on valuations than this is greatly minimized.

      Reply
  3. maurice

    I am a little hesitant. I am trying to look at the Standards and Poors 500 index, and looking at the 1 year moving average. Also, I have looking into writing covered calls.

    If you look at the moving average of the ^GSP you will see the line is converging on the SMA.

    Reply
    1. Mark Biernat

      The 365 SMA does give false signals, but rarely. If you check this it will happen only a couple of times in the last five years. A false signal is where it breaks the trend only to come back a short-term later. This is why I choose such a large-scale line to look at.
      Currently the stock market is closing in on the trend line and seems like it could break it.
      However, I try not to second guess the line and be clouded with my own fears.
      Rather, I use this mechanical strategy to control my sentiment.

      As you can see it looks like the price or index got too far away and will either break the trend or bounce off the line.
      Since the market index has broken the 50 day moving average and other MA people are jittery. I am a bit, as the economic news is horrible. But being cool and calm, if you have money in to invest and have identified values, you could go in gradually. Not bet the farm on one day. I do this when I am unsure.

      If you do not have a lot of money or paper trading. The SMA trend is still intact. If the market breaks this, calculate your downside and if you can afford this percentage loss.

      All investing is a risk. I try to minimizes my risk with mental stops on the moving average.
      The stock market is a hard market these days until we see real recovery in the economy, it might be this sideways market for a while.

      Reply
  4. Adam

    Good introduction. Moving averages are very useful and although they lag behind the price action they are useful in determining the general trend of an asset. I like to use 5 EMA and 50SMA, confirmed with a 200SMA. There are literally hundreds of custom indicators out there and signal services that use moving average crossovers for alerts. Example: the crossover signals must be confirmed by candle formations and possibly other indicators. Personally I like to trade on first pullback right after a MA crossover and use tight stops for optimum ROI.

    Reply

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