You can use many types of technical trading strategies to monitor share prices and, more importantly, buy and sell signals. While some of these trading strategies are highly technical, there is one known as the simple moving average chart. Is this too simple to be of any use to execution-only traders? What exactly does it show?


The trend is your friend


If you take a basic share price in isolation, one which is perhaps volatile, it is not always apparent if there is a trend. When you use moving averages, you create smoother lines,taking out the volatility. This allows you to see the "real" direction of the share price, and despite being described as "simple moving average" charts, they can be very informative!


How do you create a simple moving average chart?


Many execution-only traders will look for short-term buy and sell signals across various charts and technical analysis strategies. Of course, the simple moving average is the most basic technical strategy, but in all honesty, it is one of the most useful. So how does it work?


The basics of the simple moving average strategy


This strategy involves the creation of a graph which will show four different lines, the share price and three moving averages. To recognise trends, it is probably worth looking at a minimum 12-month share price chart. We then add three lines, which are moving averages of different durations. While there is no hard and fast rule, many people use the nine-day moving average, 38-day moving average and 90-day moving average. As the term suggests, the nine-day moving average is simply the closing share price of the last nine days divided by nine, and so on with the 38-day moving average and the 90-day figure.


Bullish strategy


As the share price moves, it will fall below and rise above these moving averages at some point. The first bullish sign is when the share price moves through the nine-day moving average. This indicates that a degree of momentum is starting to build. Next, as the share price moves through the 38-day moving average, this suggests that the momentum is getting stronger. Finally, a move through the 90-day moving average can indicate a strong trend. So is that it?


No, there is more. As the nine-day moving average moves through and above the 38-day moving average, this is a sign of strength. A strength which is further enhanced as the nine-day moving average moves through the 90-day moving average. However, for many people, the strongest signal that a trend has been entrenched is when the 38-day moving average moves through the 90-day moving average - sometimes referred to as a Golden Cross. The best way to look at a moving average strategy is momentum, whether on the upside or the downside.


Bearish strategy


A simple moving average chart will also show the emergence of a bearish trend as the share price crashes through the various moving averages. This indicates that momentum has been lost, and the trend is changing. The new trend is further entrenched as the share price falls through the nine-day, 38-day and 90-day moving averages. This is the opposite of the bullish trend where the share price moves upwards through the moving average lines.


How strong are these signs?


As the share price moves through the nine-day moving average, this is the weakest sign. While the strongest sign is a move through the 90 day moving average. The sooner you act, the greater the potential if the trend is maintained and strengthened. However, dealing on the nine-day moving average is risky. By the time the 90 day moving average has been breached, much of the upside or downside will already have occurred. Therefore when planning trade execution, it may be sensible to take into account the fundamentals of the company as well as market sentiment.


Do we tend to overcomplicate trade execution?


As an execution-only trader, we tend to overcomplicate investment strategies as we try to perfect trade executiontiming. However, if you look back at various examples of the simple moving average, you will see the share price gaining or losing momentum as it moves through each of these lines. In addition, if there is significant trading volume, this can further enhance and rubberstamp the emergence of a new trend. Simple but very effective and used by many execution-only traders!

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