Swing Trade Setups Part 2: Moving Averages

 [ This is the 2nd article in a series, describing how I trade.  You can start with Part 1 here ]

Here I am going to continue to show you how I build on Part 1 and look at the moving averages to determine whether to take a trade or not.  We have been analyzing AAPL and ON.

Starting again with AAPL, I’m going to show you the 3 moving averages I like to use and how I use them.

Here’s the first chart for AAPL:

My Moving Average Rules

They are:

  1. The closing price needs to be below the 10-day Moving Average
  2. The 50 day Moving Average needs to be above the 200 day Moving Average
  3. The 200 day Moving Average should be upward sloping

First… a quick note about moving averages.  They are used to smooth out the day to day prices, producing an “average” price over a certain timeframe.

For simplicity’s sake, let’s look at a hypothetical example of a 2 day moving average.

Let’s say on day one the price was 5 and on day 2 the price was 10.  The average price is therefore 7.5 (5+10) divided by 2(days).  The third day, lets say the price is 15.  The average price price is therefore 12.5 (10+15) divided by 2(days).  Notice how the first day was dropped and the new day was added.  That’s all a moving average does.  The line comes into play when all of these price points are plotted: 7.5 would be one plotted, then 12.5 plotted and so on…until you have a nice line that smoothly moves along as each average is plotted through time.

Obviously this example was extreme…nobody uses a 2 day moving average, that would lead to sharp moves.  The point of a moving average is to smooth out the day to day prices so one can see where things have been and where they might be headed.

So let’s start with the 10-day moving average that I listed.  I always use this for one reason: I am trading reversals.  I must have the current price be lower than some previous point, right?  After all, how can you have a positive reversal if there was never a decline?!  To make it easy, I use the 10 day Moving Average in all of my screens, basically programming all of them with something like “Current price is < 10 Day Moving Average”.  Any stock below the 10 day moving average is therefore a potential swing trade candidate for me.

But I refine it further…

The 50 Day Moving Average has to be above the 200 Day Moving Average.  Why do I do this?  I want a stock that has a recent history of showing positive upwards movement relative to a longer-term trend.  I am trading positive reversal pattern here!  I want a stock that has buyers.  A winner.  A stock that is moving in the right direction recently.

This way, when there is a decline, the recent price history gives confidence that the decline is only temporary.  i blip on the radar.  Current holders buy move to add to their stack because it’s a bargain.  New buyers jump in because it is also a bargain to get the chance to buy on the pullback because they feel confident that the price is heading higher.

If the current price was below the 50 Day Moving Average, we have a stock that is not behaving well.  it is not moving higher, and has likely been in a decline.  Why would I want to risk buying on the chance for a reversal, when the trend over the last 50 trading days (over 2 months) has been below 200 day moving average (10 months)?!  No thanks.

The final step regarding moving averages is to look at whether…

The 200 Day Moving Average is upward sloping.  This one has the same theme as my 50 Day Moving Average rule…I basically want to enter a stock that has been moving up on buying pressure.  After all, for the last 8 years (it’s 2018 now) we are in a bull market.  I’m not going to waste my time on lower opportunity stocks that are not trending higher in a bull market.  A stock that isn’t doing this and trending higher, is sick.  Swing trading positive reversals on a stock that has a downward sloping moving average has lower odds of working out than a stock that has long-term buying pressure.

Oh, before I forget, here is the chart for ON…you can see it also checks out well!

Up Next: Adding support and trend-lines to these charts

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Swing Trade Setups Part 3: Support and trendlines

The Greedy Goblin

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