Tales of a Technician: Moving Average Signals
August 13, 2019
Last update: August 2021
Last week, we introduced you to the mighty moving average indicator. Today, we’re continuing our exploration by focusing on momentum, trend reversals, and support/resistance.
Momentum
Momentum is typically expressed as the distance between pivots. In an uptrend, we look at the pivot highs. In a downtrend, we use the pivot lows. If the distance is expanding, then momentum is increasing. If it’s contracting, then momentum is decreasing.
Moving averages can help confirm these momentum signals, albeit with a lag. When momentum increases, shorter-term moving averages rise faster than longer-term moving averages, thus increasing the gap between them.
When momentum decreases, the rise in shorter-term moving averages slows down before the rise in longer-term moving averages, which shrinks the gap between them.
On a side note, this is one of the dynamics that drives the MACD indicator.
Floors and Ceilings
By definition, support is an area where demand > supply. It is a floor and is confirmed by an upward move in price. Resistance is an area where supply > demand. It is a ceiling and is confirmed by a downward move in price. Moving averages by themselves
Consider these areas of interest where support and resistance often end up forming. This is why we view pullbacks in an uptrend toward the rising 20-day or 50-day moving averages as potential buying opportunities.
Alternatively, rallies in a downtrend toward the descending 20-day or 50-day moving averages are potential shorting opportunities.
Reversals
Moving averages can also help spot with a trend is reversing. Specifically, this happens when the price of a stock breaks a moving average. Breaking above the average would signal a bullish reversal while breaking below would indicate a bearish reversal.
For this, I suggest using a longer-term moving average, such as the 50 MA. I’ve found using the 20-day or other short-term moving average results in too many signals. It’s just too noisy. Here’s the SPY with a 50 MA. I’ve highlighted the buy signals in green and sell signals in red.
You’ll notice that good things happen above the 50 MA and bad things happen below the 50 MA. Now, not all signals are perfect. There have been many times over the past two years that a break below the 50 MA would have turned you bearish, only to see the stock pop right back above the 50 MA and generate a bullish signal. No signal works all the time. But it’s still been a valuable metric to use that keeps you on the right side of the primary trend.
- When above the 50 MA, the path of least resistance as up. The market is innocent until proven guilty.
- When below the 50 MA, the path of least resistance is down. The market is guilty until proven innocent.
Next week in our final installment of this series we’ll explore moving average crossovers.
Financial freedom is a journey
Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.
Legal Disclaimer
Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.
All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.
