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Look, I get it. Learning the ropes in the market can seem like a daunting task.
Unless you're an experienced trader, trying to follow along as someone spits out a bunch of technical indicators and unfamiliar jargon can leave you feeling like you're in over your head.
But as someone who started form the bottom with very little knowledge of the market many years ago, and has since trained hundreds of thousands of people how to effectively trade, I'm here to tell you that you've got this.
And I want to help you get there.
Today, I want to provide some insights into a phrase you may hear or see a lot when researching your trading.
It's an incredibly simple yet important indicator that traders have been using for decades to spot stocks on the move, both up and down, and plot their trades by.
And it's something I've been using as the basis for one of my best-performing trading strategies over the past year.
Let's take a look at how this one easy-to-use tool can help you improve your trading...
The Power of the Moving Average
The basic function of a moving average is to smooth out price data over a specified amount of time by calculating an average price movement.
This allows traders to more clearly see trends in price movement by filtering out short-term price fluctuations. It is also useful in determining support and resistance levels.
A Simple Moving Average SMA is calculated by taking the close prices of a security, adding them up, then dividing by the number of days.
To give you a simple example, let's say The Coca-Cola Company (KO) closed at $61, $65, $62, $67, and $66, the formula to calculate a 5-day SMA would be...
(61+ 65+ 62+ 67+ 66) ÷ 5
Your SMA for the past 5 days would equal 64.2. Moving average can then be charted by taking the next day's closing price and adding it to the equation, while removing the oldest day's price.
While this data can be very useful in and of itself for establishing trend and momentum, and even more powerful indicator occurs when a short-term moving average line crosses over a longer-term moving average line on a chart.
Since short-term moving averages typically move with greater volatility than the longer-term moving averages that are more smoothed out, a short-term moving average crossing above a long-term moving average is regarded as a buy signal, since the price trend is moving up. A short-term moving average crossing below a long-term moving average is regarded as a sell signal.
This has been a strategy used to great effect by traders for years. In fact, I recently broke down the moving average cross and why it is such an effective tool during an appearance on Money Morning Live.
But as you'll see if you watch the video, I also discussed the limitations and downside in how most analysts use moving averages.
There's a much …
About the Author
Tom Gentile, options trading specialist for Money Map Press, is widely known as America's No. 1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Tom has taught over 300,000 traders his option trading secrets in a variety of settings, including seminars and workshops. He's also a bestselling author of eight books and training courses.