There are about as many variations on the moving average as there are investors using them. While it’s generally understood that no one configuration is going to be the holy grail of predicting stock prices, each investor has their own baselines or favorites that they come back to.
Below, I’ll talk a little bit about how I’ve been using MAs lately. Then I’ll look at some of the MA setups which seem popular online today and make some observations based on them.
What’s a Moving Average?
As typical, Investopedia is a good place to start for those of you unfamiliar with moving averages (MAs). StockCharts.com also has a great article on moving averages which goes into a little more detail. Now, with that out of the way, the big question is…
Which MA should I use?
With so many lengths and types of moving averages out there, which should you use? The general consensus is that shorter-length MAs and “exponential moving averages” (EMAs) are better for short-term trading, while the longer-length and “simple” MAs are better for long term traders. That leaves a lot of room for interpretation. Here is how Investopedia explains some of the more popular lengths in their tutorial:
- 20 day – provides a very volatile, choppy line. It isn’t the most accurate, but is probably the most useful for short term traders.
- 30 day – similar to 20 day but provides a bit more certainty for the trend.
- 50 day – moving averages provide a much less volatile, smooth line. This can be used to detect somewhat longer term trends.
- 100 day – similar to the 50 day, it is less volatile, and one of the most widely used for long term trends.
- 200 day – even less volatile, more of a rolling chart or smooth line. It doesn’t react to quick movements in the stock price therefore it is rarely used.
If you are interested in comparing different “types” of moving averages, the StockCharts article has a good discussion of using simple vs. exponential MAs which is a good start (emphasis mine):
Which moving average you use will depend on your trading and investing style and preferences. The simple moving average obviously has a lag, but the exponential moving average may be prone to quicker breaks. Some traders prefer to use exponential moving averages for shorter time periods to capture changes quicker. Some investors prefer simple moving averages over long time periods to identify long-term trend changes. In addition, much will depend on the individual security in question…
The Trial and Error Approach
As the StockCharts quote suggests, it’s rarely so black and white when deciding which MA to use. The real answer is “it depends”. (I know I’m sorry.) But it works well here because a good practice is to try out many different MAs on a chart as you can to see which have been more indicative in the past. Different stocks have different kinds of investors, and different kinds of investors are going to be using different MAs to inform their trades.
This series of charts follows some of the thought process I was going through while working out what to do with my position in Bed Bath and Beyond (BBBY) last week.
Here I’m taking a look at some faster moving averages, including one of my favorites: the 15-day MA. We’ve just punctured the 30-day MA and might expect a bounce off it as it switches from resistance to support. Oh, but what happened back on June 19th? The price didn’t stay above the 30-day MA for long. Hmmm. Is the 30-day MA setting me up for a whipsaw?
Okay, now I’m using some slightly slower moving averages. The 50-day MA is a staple, but I threw in the 40 and 60-day MAs in case they followed the price tighter. Actually, the 50-day MA looks like it provided resistance back on that June 19th plunge. The price crossed above the MA intraday, but couldn’t lock it down. Am I going to see that same resistance this time around? Maybe I should sell before the 50-day MA.
Here’s a look at the 30 and 50-day MAs on a one-year chart. This view lets me see what I could potentially miss by basing my trade off the slower 50-day MA. Good news is that the 30-day and 50-day MAs predicted the last big rally in BBBY at the same time back in March. In November 2005, the 30-day had a little bit of a jump on the 50-day, but there was still profit to be had if you bought in after the 50-day was crossed.
Based on the above, I decided to use the 50-day MA to inform my trade (I say “inform ” because there are many other factors involved as always). I’m expecting the 50-day MA to act as resistance. A punch through this level would be bullish, but I’m not too optimistic about that considering the bear market we seem to be in.
Popular Moving Averages on The Web
So what kinds of moving averages are people on the web using? Here is a small sample of MAs being used by investing bloggers:
Trader Mike: Mike is typically using the 10, 50, and 200-day MAs in his analysis.
Uglychart.com: There’s not a lot of talk about MAs done on Ugly’s blog, but you can see the 5 and 20-day EMAs in some of his 15-minute candlestick charts.
Phil Town: While Phil doesn’t post charts on his website, his book Rule #1 (review)
Matthew Frailey (via StockCharts Favorites): Matt uses the 50 and 200-day MAs as a default but is not afraid to use whatever MA is needed to get the job done. A quick scan of Matt’s first page of charts shows use of the 20, 42, and 65-day MAs for particular indexes.
Robert E. New (via StockCharts Favorites): Rob uses 20, 50, and 200-day exponential moving averages.
Rodney N. Gorchinsky (via Stock Charts Favorites): Rodney is consistently using the 21, 55, and 233 EMAs. Interesting choices.
Here are some of the default moving average settings for some online charts:
BusinessWeek: 30-day simple MA.
Yahoo! Finance: No default.
MSN Money: 50-day simple MA.
E*Trade (requires an account): 50-day exponential MA. Adding a simple MA to the chart defaults to 13 days.
StockCharts: 50 and 200-day simple MAs.
InvesterTech: 5, 10, and 20-day simple MAs.
Observations
1. I think it’s interesting to note that Trader Mike, a day trader, spends a lot of time talking about 50-day and even 200-day moving averages, while Phil Town, who’s motto is to invest as if “it were the only business you were going to own for your family’s financial future” focuses on the 10-day and 30-day moving averages. This does make sense though, as these investors have basically inverse trading philosophies:
- Mike is buying (or shorting) stocks based on how he expects the security to perform short term, but he makes sure that his trade is in alignment with the long-term trend.
- Phil is buying stocks based on how he expects the security to perform long term, but he makes sure he buys in while short-term conditions are good.
Both traders have a holistic approach to investing, each focusing on one timeframe, while using technical analysis to double-check the other timeframe.
2. The other thing that pops out at me is how almost every MA used is a multiple of 5. This makes sense as there are 5 trading days in a week. However, some people do use 7, 14, and 21-day moving averages which lines up with a calendar week, which as far as I know is just a coincidence. The advantages I see to using atypical MAs like the 14-day MA are two fold: (1) you’ll get a jump on the guys who are investing based on longer-term MAs and (2) you’ll get a stronger confirmation of the breaks that cross over shorter-term MAs. I like the 15-day MA for this reason. I feel I’m getting the jump on folks using the 20-day MA, while at the same time some I’ll avoid some of the whipsaws caused by trading of the faster 10-day MA.
An article on Moving Averages at Incredible Charts gives us this rule of thumb:
It is best to use a moving average that is half the length of the cycle that you are tracking. If the peak-to-peak cycle length is roughly 30 days then a 15 day moving average is appropriate. If 20 days, then a 10 day moving average is appropriate.
The author uses similar reasoning to myself to explain the odd-length Mas:
You will, however, often find traders using 14 and 9 day MA’s for the above cycles in the hope that they will generate signals slightly ahead of the market.
Conclusion
I am very interested to hear our readers’ thoughts on moving average lengths and types. What are your favorites? Which are you wary of? Post comments below to join the discussion.