Of the hundreds of ways to select stocks for a portfolio, one of the most popular methods is based on the moving average of price data. In fact, there’s an entire group of techniques centered around using average prices of individual shares. Based on your account size, investing goals, risk profile, and personal preferences, there’s bound to be one to suit your needs. If you like the idea of using historic price data to predict future movement, then check out the following variants of this popular conceptual trading framework.
Averages are typically simple to understand, easy to calculate, and make logical sense in terms of how the market operates. They are not arcane, complex, calculus-based indicators that require the use of downloaded apps and proprietary black-box magic. Long-term investors love averages and tend to keep their eyes on a key parameter: the 200-day trend line. The 200 is part of most charts’ built-in indicator menus. You arrive at the day’s 200 by averaging a particular share’s last 200 session’s prices. That’s it. The power is in the fact that the line moves very slowly and often reveals major upward or downward moves, making it ideal for people with long time horizons.
A favorite of both new and experienced traders, the cross technique is ingenious. The most common version uses the 50-day and 200-day lines, but you can use any diverse pairing you prefer. How does the technique work? When the short timeframe line crosses above the longer one, you have a buy signal. When it crosses below the long line, you view that event as a signal to sell. The crossover system is robust enough that anyone can use it, from day traders to retirement planners.
When it comes to day trading, scalping, and other super-short time frames, it’s often helpful to speak of minute-long averaging. Scalpers, who often seek to get in and out of a position in less than a minute, might use 30-second lines to make decisions. As noted above, one of the most versatile things about the MA philosophy is that it’s so adaptable.
Forget about prices for a moment. Some people who use moving average concepts in their investing focus on the number of shares that are bought and sold throughout a given session. There’s an entire school of thought behind this concept, and it’s based on watching what people buy, not necessarily what they pay for it. However, if you combine the two ideas, it’s possible to come up with a sort of momentum indicator on your own. A common version of the practice is to only enter a position when your target shares’ value and volume are rising together, which is said to be a powerful indication that even as the cost of a share rises, even more people are getting in line to purchase it.
If you’re the type who prefers counter-intuitive strategies, the counter-balancing method could be your cup of tea. Instead of looking at stock prices directly, simply observe movement of a counter asset, like gold. When gold’s price is in a long-term down trend, that would be a time to purchase a broad-based index fund.
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