Chris Rowe

Use Moving Averages to Keep Profits 'On the Move'

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Moving averages are generally used to smooth out the "noise" of the short-term volatility and, therefore, more easily identify major trends. They are also used to gauge the changes of momentum in an index or security.

The most basic kind of moving average, the "simple moving average" (SMA), attributes equal weight to all time periods and averages out the sum. So, a 20-day moving average would typically average the closing price of each of the last 20 trading days.

There are several other types of moving averages, but the "exponential moving average" (EMA) attributes more weight to the recent price activity. Some believe it makes more sense to use EMA over the SMA, as recent price is more relevant, but it's really a matter of personal preference.

Personally, I prefer the EMA, although there is a place for both when doing technical analysis for your own portfolio.

Which time periods should be used to identify which trends?

• To identify the short-term trend, a 10-day (or two-week) moving average is typically used.
  
• To identify the intermediate trend, a 50-day (or 10-week) moving average is typically used.
  
• To identify the long-term trend, a 200-day (or 40-week) moving average is typically used.

Keep in mind that the direction of a trend can be defined either by the direction of moving averages, or by highs and lows. For example, higher highs and higher lows typically constitute an uptrend, and vice versa. But for the purpose of this discussion, we'll focus on moving averages.

I have read, and I can also write, hundreds or probably a thousand pages on moving averages, but let's stick to the basics here.