Trading by using a simple moving average chart (summary)
- Simplify your trading by taking a long-term view on just a Simple Moving Average (SMA) chart.
- What proper length of time to use when charting stocks on SMA.
- How to cut losses while allowing profits to run.
- The down side to SMA technical analysis trading.
Disclosure: I own some or all of the stocks being mentioned for this article. The stocks mentioned have been thoroughly researched and real money has been invested in them for growth and income purposes. Some of the stocks have been in my portfolio for longer than 1 year. My intention is not to pump up interest in these stocks, but to provide genuine and thorough research so that you can make an informed decision.
If you rely on technical analysis to trade like me, you would have already been very familiar with how simple moving averages work.
Without getting into modern portfolio theory or going down the list of the hundreds of technical analysis studies out there, I’ll explain with examples on what to look for when you’re planning your trades.
Note: This article is aimed for beginners, but I’m making a few assumptions to keep this information relatively short and easy to digest.
I’m assuming you already have a foundation of what the stock market is, you have a brokerage account, and have some funds in there to trade. And you already know you should be investing in the stock market and have done some research on trading opportunities. If you are looking for a commission-free broker we recommend Robinhood then take a look at this story on how to make real money in the stock market.
Now that we have cleared the air, let’s begin!
First, type in a ticker symbol using your broker to chart the stock. This will reveal the price movement over the past year (this depends on the default view). Here’s an example:
I want to show you a relatively smooth trend line example so that you can see clearly the difference between the price and the SMA line. Using Adams Diversified Equity Fund Inc’s YTD chart you can see that in the beginning of the year, its price is slightly below the 100-day moving average.
Within a few days, the price gradually broke above the SMA trend line, and it hasn’t looked back yet.
Assuming you placed a buy (long) trade on ADX on January 9, 2017 at $12.94 when the price closed above the moving average line. Your ADX stock would be valued at $15.33 today, which represents an 18.46% return for 10 months.
The total return would actually be a little higher because if you look closely on the chart, it shows dividend payments were made quarterly. By the way, if you’re looking for additional diversification, take a look at how dividend stock investing works and why you should have them in your portfolio.
ADX stock is a great example of a shorter-term view using the YTD prices against the 100-day SMA trendline. However, you’ll need a much longer time horizon in the stock market to see how your trade will unfold.
I’m a fan of Amazon stock for a much longer holding period like 3 to10 years at a time. Take a look at the 3-year chart of Amazon stock.
If you’ve been trading for quite sometime, you may remember Amazon emerging among the sea of casualties of the dot com bust. In 1999, Amazon traded at around $7 per share. It has had an amazing run since then.
But take a look at where it is now, if you actively watch the price movements of Amazon and combine it with a 100-day SMA parameter, you can see that the entry price was around March 2015 at $381 per share. As time went on, SMA continued to trend higher and higher caused by the uptrend in Amazon’s price.
You can even put a stop loss on Amazon stock right now at $785 per share and still make a profit, if you’re inclined to do so.
Using the 100-day SMA trend line as both the entry and exit signal could be very profitable for you as long as you maintain a long term view. Yes, it’s very difficult to remain impartial to your own trades especially when real money is on the line. Believe me, there have been several occasions where I sold a position too early because I want to take profits off the table. Only, to discover several weeks later that if I had held, it actually would have doubled my money!
Or if you look on the flip side.
Again, many many times before where I held onto losing trades, despite what the data shows, only to realize weeks later that I’ve lost over half of my money trying to prove myself right. Cutting your losses early and realizing you made a mistake is a very large part of the psychology that goes into trading.
Using a technical study like the Simple Moving Average set to 100 days (for a long term view) allows you certain freedom to let your trade unfold. It can provide you with a guide to know when to enter a trade and a trailing stop loss while you’re in the holding pattern.
But it’s not always this easy. Here’s an example of when SMA simply may not work as your only guide to trading.
Tesla hasn’t been the most easy to trade lately. If you’re a fan of the company and many people are, you would be inclined to get in on the action no matter what the price is. And that’s fine, Tesla has a bright future as it enters more industries in the renewal energy sector.
However, if you’re simply looking to make a short-term profit on Tesla with trading using SMA, you may want to look elsewhere. The price action in the previous 2 years has not been very friendly to traders who spot opportunities using SMA. At a glance it has produced at least 9 false positive signals making this a difficult pattern to trade.
If you’ve been faithful to Tesla and haven’t given up yet, you are in for a profitable run, so far. The latest buy signal happened on January 8, 2017 at $237 per share. Hopefully, it remains above that and you can sell for a tidy profit.
So, trading using the simple moving average can be a profitable overall strategy to include in your overall portfolio management. Again, I must emphasize that you can use SMA to trade both short-term and long-term but I prefer you take a longer view.
SMA 100 days on a YTD chart is what I use to spot an entry signal on a stock. I usually adjust the time frame to determine the overall trend of the stock.
Here’s how I would rate trading on SMA set to 100-days on a 2-year chart.
- 10/10 For simplicity. Keeping your trading as simple as possible is very important. SMA removes the complexity out of trading decisions.
- 9/10 For false-positives. A technical analysis study should provide you with the least false-positive signals. SMA 100-days on a 2-year chart should not have that many trading signals. Stocks like TSLA, prove that SMA can produce false positive signals.
- 7/10 For stop loss management. SMA makes it very easy to set a trailing stop on your stock holdings. However, the actual price and the moving average price can sometimes have a huge gap, leaving you unprotected from sudden volatility.
One last thing to note is that when the market moves into a more volatile period (and this will happen), prices will move so fast that simple moving averages become worthless on its own.
Take a look at our monthly performance with ETF trading here.