If you’re learning how to use technical analysis, moving averages are something you should keep in your tool kit. This is something I use all the time to signal when I should be entering an options position on a stock. Moving averages are a tremendous trading tool. However, you might wonder which time frames work best together, and whether your averages should be based on hourly, daily, weekly or minutely charts. The right answers depend on your style of trading. Here are the basics on how to determine the moving-average periods and time frames that are most suited for your style.
How to Use Technical Analysis: Moving Average Basics
Generally, the longer you expect to hold the security, the longer the time frames you want to look at. Swing traders and investors typically want to stick with the daily or hourly chart to get an idea of the overall trend of a stock. For crossover strategies, the daily time frames generate signals more slowly, but that’s fine if you’re not trading minute by minute.
Here’s a look at the 20-,50- and 200-day simple moving average (SMA) plotted on the daily chart, of the SPDR S&P 500 Index ETF (SPY).
Day traders, meanwhile, need to look at shorter windows of activity, such as the hourly, 15-minute or 5-minute moving averages. These time frames generate more signals for crossover strategies, with the moving averages capable of creating strong impressions about short-term trends.
Continuing with SPY, here’s a look at those same moving averages plotted on the 15-minute chart.
Notice the difference between the two charts. The daily chart shows the long-term trend, while the 15-minute chart shows the short-term moves up and down.
Which period is best?
There is no “best period” for moving averages. It all depends on your trading style. If you want more signals generated, set the periods to a smaller number. On the other hand, if you want a good look at the big picture, set the periods to a higher number.
Note that when you set the periods to a smaller number, they tend to follow the price more closely than moving averages with longer time frame. Here’s a look at the 5-period and 10-period simple moving averages plotted on the 15-minute chart, on SPY.
I’ve found the hourly chart works best for my style of trading. Basically, I use the 13- and 30-hourly SMAs to signal when a trend might shift. Thereafter, I’ll look to buy options on the stock in an attempt to double my money, or even more.
For example, here’s a look at a chart of TripAdvisor (TRIP). I call this chart pattern the “money pattern” because it’s a high probability trading setup and you could potentially take part in large up or down trends.
I actually used this crossover to signal that I should be buying call options in the name, and I did. With just this simple crossover and buying call options instead of stock, the trade generated a return of over 400%!
Determining how far to look back for moving averages all depends on your style of trading. To see more trade signals, opt for shorter periods and shorter timeframes. To use charts and patterns as a swing trader or investor, however, look at periods of 20 or more, most likely on the daily charts.
Jeff Bishop is lead trader at WeeklyMoneyMultiplier.com and widely recognized as the Mensa Trader. He runs short-term trading strategies, using stocks, options and leveraged ETFs.