Trading Options: Using Technical Analysis to Design Winning Trades (Wiley Trading) by Harmon Greg

Author:Harmon, Greg [Harmon, Greg]
Language: eng
Format: mobi, epub, pdf
ISBN: 9781118679173
Publisher: Wiley
Published: 2014-01-31T00:00:00+00:00

■ Moving Averages

The use of moving averages was discussed in Chapter 1, about identifying the trend. There we learned that a simple check is to see if the price is above or below the moving average and the direction of that moving average, up or down, to identify and confirm the trend. This applies to individual stocks as well. But there is a lot more that can be said about moving averages. They can act as support and resistance like trend lines and horizontal lines. Traders tend to focus on the 20-, 50-, 100-, and 200-day moving averages for swing trading (holding a few days to a couple of weeks). But some will swear by the 144-day, since it is a Fibonacci number, or the five- or nine-day if they are very short-term traders. Moving averages can be used on any time frame as well. A day trader might look at the 20-period moving average on a five-minute chart whereas longer-term holders may refer to the 20-week (very close to the 100-day) moving average.

These moving averages can be simple or exponential, referring to how they are calculated. Simple moving averages (SMAs) use an arithmetic average of the stock prices, but which ones? Opening, closing, high, low, or average? Most traders and investors presume the closing price to be the most important and use this as the default for calculating a moving average, even if it is for an intraday period. So a 100-day SMA is just an average of the past 100 days of prices. The exponential version (EMA) gives greater weight to the more recent prices than it does to the older prices. In this way it reacts to price changes faster. Traders use 9-, 12-, and 26-day EMAs most often to trade from. Remember that the latter two are also used to create the MACD indicator. To me, if you want the moving average to react faster, then you should just use a shorter time period for your calculation on an SMA rather than using an EMA.

I use the 20-, 50-, 100-, and 200-day SMA on my charts. Depending on the strength of the trend and the particular stock, some can be more useful than others. The chart of Burger King Worldwide in Figure 6.9 is a good example of how they can be used to trade from. Notice that over its short life since exiting bankruptcy, it has bounced off of the 100-day SMA four times. Each time provided a long trade opportunity, three of them good for more than a 15 percent move.

FIGURE 6.9 Burger King Worldwide—Moving Average Support

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