Moving averages are added to a price chart to help interpret price action and to easily identify trends. There is nothing magic about a moving average.
It is simply the average price over a given period of time that changes as older data is replaced with new data. The moving average is like a moving trend line.
Moving averages can be used on any time frame. The Money Flow Trading system focuses on daily and weekly charts. The system plots three main moving averages. On a daily chart.
– The 5 day exponential moving average
– The 10 day exponential moving average
– The 20 day simple moving average
See chart example:
For more on moving averages see (The Money Flow Trading System free book).
I do like to keep an eye on the 200 ma.
When moving averages properly align in numerical order and in slope your decision is easy and you will find making money even easier.
When the moving averages get out of wack these will be points of indecision in the market and scream caution. These are zones where bulls and bears are in disagreement. While a crossover of moving averages can signal a trend change don’t forget this is a zone of indecision as well.
This often leads to whipsaws and potential losses for traders. See the chart of NFLX below. The line with arrow highlights when the moving averages are properly aligned.
The bulls are making money….nice upward trend.
when moving averages numerically align (5,10,20) bulls are making money.
The opposite is also true, when moving averages numerically align in reverse (20,10,5) bears are making money.
When moving averages aren’t aligned numerically the market trend is suspect and possible about to change.
Look back at the NFLX chart and notice the blue circles. These are zones of indecision. The 5 ema is crossing back and forth the simple 20 dma. These are the battle zones.
These zones can chew you up and cause you to take a lot of small losses. Death by 1000 paper cuts. The signal is caution.
The chart below is TSLA. In this chart we see some good trend action but there are a lot of zones of indecision. Again the line and arrow highlight when the moving averages are properly aligned….and when they are not.
The really profitable moves happens once there is proper numerical alignment (5, 10, 20) of the moving averages and they slope in the direction of your trade.
This is when the easy money is made. No hard thinking required. Nothing complicated or hard calculations.
The moving averages help you determine the direction of the money flow i.e. The trend.
If the 5 ema closes above the 20 sma you look to enter a long position.
If the 5 ema closes below the 20 sma you look to hedge, close or reduce your position size.
If the 5 ema closes below the 10 ema but the 5 ema is still above the 20 sma and MACD crossover signals a sell lock in some price appreciation . Look to sell 1/4 of the position and lock in some of your gains.
If price completely reverses and closes above the 20 sma and 5 ema is still below the 20 sma that is a bullish reversal.
This is a buy signal as long as it is confirmed by the MACD. Look to put on 1/4 of a position or add to current 50% by 1/4 increase. Add the remaining 1/4 when the 5 ema closes above the 20 sma price is above the moving averages and MACD confirms.
As price, moving averages and other indicators confirm the new trend or end of trend I want to scale in/out of the trade. I am always scaling into and out of trade positions as The Money Flow in and out.
I want to take down portion of my trade as the 5 ema closes below the 10 ema but not the entire position. The market can reverse course quickly. Moving average crossover zones are areas of conflict.