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Intermediate 4: A guide to using moving average in predicting market turning points

October 6, 2022
moving average chart

Being a trader is not an easy job because you need to learn all the strategies necessary to help you make the right decisions on every trading day. One of these is knowing how to predict market turning points. Although the market can shift quickly, predictions will give you a better chance of getting good results for your trade as opposed to going in blind.

A moving average is the superimposed line over a stock’s price action that you see on a line chart. It represents the total closing prices of a security in a specific number of periods divided by the total number of periods. When you’re in trending markets, moving averages can be used as an area of value. 

There are two types of moving averages: Simple Moving Average (SMA) and Exponential Moving Average (EMA). 

Here’s what you need to know about the moving average and how a trader can use it for predicting market turning points:

What is a trend? 

If you want to use moving averages successfully, you need to understand trends first. A trend is essentially the direction in which a price is going. It could be an uptrend, downtrend, or sideways trend, but remember that these prices rarely continue in a straight line due to constant market shifts. This is why you need the moving average to help determine the exact direction where a trend is going.

How do you calculate a moving average?

To calculate a moving average, you need to define a specified period, the most popular of which is the 50-day moving average. Here, you’ll need to add the closing prices for the last 50 days and then divide it by the number of periods, which is 50. If you want to use the same method over the next few trading days, replace the oldest number with the most recent closing price and follow the same calculations.

You can also use the same calculation for weekly prices, monthly prices, intraday prices, and opening prices. This will depend on what you think will guide you in predicting market shifts, so you’ll also know when to buy, hold off, or sell.

How do you use a moving average as entry or exit?

A moving average is a powerful tool for predicting market turning points, which will help you plan your entry and exit strategy wisely. One of the easiest methods traders use is crossing two or more moving averages with a short- and long-term calculation. For instance, if a short-term moving average crosses below or above a long-term moving average, that could be a signal that a trend is gaining strength or if it’s about to reverse.

In most cases, a short position is determined when a short-term average crosses below the long-term average, while a long position is determined when the short-term average crosses above the long-term average.

Finally, there’s support and resistance, which you probably know by now as the downward or upward direction of a trend. How does this relate to the moving average? When you calculate a moving average and plot it on a chart, it could be an early determining factor of a support or resistance level. This will help you decide if you should buy, sell, or sit it out until the market is more favourable to your goals. 

Moving averages can help you make proper trading decisions if you know how to use them right. 

So, learn how to maximize this strategy and other methods for trading with the help of experts, like VT Markets, in a community where you can get useful trading insights.