Why Moving Averages are Popular

by : Leroy Rushing

Moving averages are used by every trader, even those that don’t favor technical analysis. Why is this indicator so prevalent, even among traders who enjoy fundamental investing?

KISS: Keep It Simple, Stupid

One of the biggest reasons that moving averages are so popular is due to their simplicity. While profitable traders have been using a moving average on their charts for quite some time, the moving average remains one of the most simplistic forms of technical analysis. Uptrend, downtrend, or sideways trend, moving averages have been perfected for their use as support and resistance lines and as a general prediction of where the markets are headed.

Day trading strategies with any trader frequently involve the use of one or many moving averages to guide the price. Professional traders use moving averages to coincide with the thinking of the "big boys" on the market. Many investment firms and trading houses employ moving averages to see the previous X days of price movement. Creative techniques are used with moving averages to perfect their predictions. For example, a moving average may be set back on the chart by a few bars to make it even more of a lagging indicator, or a number might be modified to exclude a random blip in the chart.

Track a Stock in a Short Timeframe

The profitable trader also uses moving averages to see how a stock has done after a specific event, an earnings call for example. Moving averages also work as great stop losses and profit points to preserve trading capital. Many professional traders like to set their profits just below a key moving average to get out before a big bounce off a trendline.

Moving average crosses can also predict a large downtrend or uptrend by displaying when two different moving averages cross. When the short term moving average passes over a long term moving average, profitable traders recognize a momentum movement and enter a long position. When the short term average passes below the long term, a sideways trend or downtrend is likely to occur.

How to Use Them in Your Trading

A trading plan planner should be used to monitor moving averages and their result on a good trading plan. Even traders who despise technical analysis find some value in a moving average and the data it shows. Professional traders agree: a moving average is a great way to determine a reasonable value for a certain security considering its recent prices.