The moving average is a relatively simple tool available to investors. A simple moving average (SMA) is computed by averaging a particular stock’s closing price over several trading periods. Meanwhile, an exponential moving average (EMA) skews the average in favor of the most recent figures but it still considers several trading periods.

Both of these moving-average methods are valuable to traders and the choice of which to implement depends largely on the investor’s personal style. The EMA is quicker to pick up on short-term trends and breaks which is beneficial to day traders. Opposite this, the SMA is more reliable on the mid to long-term, but suffers from a built-in lag.

Moving averages basically take a varied price line and make it more visible to the human eye, therefore allowing traders to easily spot trends.  Stocks rarely move in horizontal fashion, usually there is either a demand to buy the stock or sell the stock which creates movement in the price.

The simple moving average (SMA) is the average price of a security during a specified period of time.  Used with candlesticks, a moving average calculation can also help determine the momentum of a price trend.  When the two moving average lines cross over one another, a signal to buy or sell a position is given.  As with other methods, moving averages can help determine support and resistance levels, signal a trend reversal, and entry and exit timing.  Remember, moving averages work best during a trend.  If the price action of a stock is within normal trading ranges or it becomes highly volatile, moving averages should be ignored.  They do not work well in these environments.

Here are a few of rules regarding using SMA to open and close positions.

• Day traders will be more efficient and effective using shorter term moving averages.
• When the short term SMA is above the long term EMA, go long.
• When the short term SMA is below the long term EMA, go short.
• There should be a nice margin between the short term SMA and long term EMA.
• If opening a long position, both moving averages must be sloping upward.  (Reverse if short).

Moving averages are used best to identify trends and their direction.  Using the angle of the moving average slope (up or down) will assist the trader in identifying the direction of the trend.  Moving averages can also help the day trader make good decisions on when to enter and exiting a position by identifying crossovers.