Having known what is moving average, let us understand its application. The moving average helps in identifying buying and selling opportunities. When the stock price trades above its average price it means traders are willing to buy the stock at a price higher than its average price. This indicates that traders are optimistic about the stock price going higher. So now there is more scope for buying opportunities.
How to use moving average curve
Similarly, when the stock price trades below its average price it means that the traders are willing to sell the stock at a price lesser than its average price. This implies that traders are pessimistic about the stock price movement and therefore this should be selling opportunity.
Basically, there are two conditions to follow while defining moving average trading system.
1) When the current market price turns greater than the 50-day EMA one, should buy and stay invested till necessary cell condition is satisfied
2) One needs to exit the long position when the current market price turns lesser than the 50-day EMA.
Let us understand this by considering an example of a stock ‘X’.
S no. Buy Price Sell Price Gain/Loss
1. 165 187 22
2. 178 182 4
3. 165 215 50
The first opportunity to buy was at rupees 165 as here the stock price moved to a point higher than its 50-day EMA. The next exit signal is at 187 which generated a profit of Rs22 per share.
From the above table the first and last trade were profitablebecause the stock was trending but during the second trade the stock moves sideways. Thus, we can conclude that moving averagesare helpful when there is a trend and fails to perform when the stock moves sideways.
In other words, moving average in its simplest form is a trend following system.Moving averages give many trading signals during sideways market and yields marginal profits.
The losses are minimum in a moving average system, but one big trade is enough to compensate all the losses and give enough profits. The profit-making trade ensures that you are in the trend as long asthe trend lasts. To reap more profits, a trader should select all the trading signals that trading system suggests. (The author is a homemaker who dabbles in stock market investments in free time)