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Moving averages come in various shapes and sizes. Regardless of the time frame used, however, there are a few core signals that these smoothing mechanisms generate. Here are the top three.
Trend Identification: Sometimes, the relationship between pivot highs and lows is messy. Toss in a handful of confusing candles, and you may find it difficult to discern if the trend is up or down. This is where moving averages can help. They smooth out the price action and capture the essence of the trend. If the moving average is rising over time, then the trend is up. If the average is falling over time, then it’s down.
Support & Resistance: Moving averages aren’t support or resistance by default, but they serve as gathering grounds for dip buyers and rally sellers. When a stock is trending higher, bulls will loiter near key moving averages such as the 20-day, 50-day. If prices decline to these levels, buyers usually pounce.
Trend Reversals: When prices are rising above the 50-day moving average, then the trend is up. When prices are falling below the 50-day moving average, then the trend is down. Breaking the 50-day can be an easy signal to use for identifying when the trend is turning.
Do you understand how to use these signals yet? If not, put it on your to-do list, and thank us later.
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Chart of the Day
IWM chart with MA signals
Here’s a chart of the Russell 2000 ETF with a 50-day moving average. All three signal types are labeled.
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