A big thing that trips up new traders is they get an entry signal at a breakout or a bounce off a key moving average like the 50 day simple moving average but have trouble quantifying how to let the it run if it is a winner or cut the loser short if it goes down. How to get out near the top instead of giving back the bulk of the run up on the way back down. Shorter term moving averages let you trade a big uptrend on a shorter time frame and give you a way to quantify a trailing stop and where to enter and exit if you missed a past key entry point.
I came across this quote from Market Wizard Marty Schwartz from his book: Pit Bull.
“The 10 day exponential moving average (EMA) is my favorite indicator to determine the major trend. I call this “red light, green light” because it is imperative in trading to remain on the correct side of a moving average to give yourself the best probability of success. When you are trading above the 10 day, you have the green light, the market is in positive mode and you should be thinking buy. Conversely, trading below the average is a red light. The market is in a negative mode and you should be thinking sell.” – Marty Schwartz
I agree completely with his observation and I have found the same thing in my independant chart studies. In sharply up trending stocks the 10 day EMA is respected and acts as support. At times the 10 day EMA also acts as resistance. The key is to find an up trending stock or index that respects the the 10 day exponential moving average over time and then the moving average itself can be used for entry and exit signals for short term directional swing trade identification. I primarily use the 5 day EMA, 10 day EMA, 20 day EMA, and 30 day EMA in my own personal trading.
What moving averages do is identify and track trends, they quantify entry and exit points and are not open to opinion: they are facts. They track the real flow of capital and are used as signals by many traders, that is why you will see reactions many times at these key levels.
This is a simple system that can get new traders trading on the right side of the market with advice from the pen of a real millionaire market wizard. Marty Schwartz had some of the best monthly returns of any trader in history. He also won a championship day trading competition using this as part of his process.
Check out my book Moving Averages 101 for more information on what I learned about using them as trading signals.
