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Trading 101

Trading 101: Moving Averages and Moving Average Strategies

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What are Moving Averages?

Moving Averages are among the most popular trend indicators in Technical Analysis. They provide a simple, yet powerful visualization of the ongoing trends in an asset. They are used for a wide variety of reasons, primarily for trend following and reversal strategies.

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Simply put moving averages are connected points calculated for every day (or whatever the timeframe is). The calculation itself is simple; you take a given number of previous days and calculate their average. Of course, you don’t have to do the calculations yourself. All basic charting software and trading platforms do the math for you and plot the moving average (or up to dozens of averages for that matter) on the chart of the asset.

How to Interpret Moving Averages?

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If you want to know what a moving average means, just think about that it is nothing else but a smoothed way of describing the price movement itself. So, if the MA is rising that means that the price trends upwards on the given time-frame. It is that simple. Also, if the current price is above a certain MA that usually means that the trend on that time-frame is still intact.

Now the interesting part is when you use the MAs for comparisons. You can compare two MAs with different time-frames or simply compare the value of the MA to the price itself. This might be helpful for plenty of reasons, but the most important conclusion that you can make is the alignment of a short-term and a longer-term trend. Like this, you can spot trend reversals, pull-backs, and exact entry and exit points. How? Let’s see some examples.

How to use it Trading?

Moving averages can be used in virtually unlimited ways, but as always, keeping your strategies simple is advisable. So let’s see the basic but most robust applications:

1.     Determine the ongoing trend by comparing the price and a certain MA, and its direction.

This is as simple as it gets; first, you take the direction of the MA, then you take a look at the price and see whether it is above or below the MA. If the MA is rising and the price is above it then it is confirmed up-trend. According to that, you should only trade on the upside on that particular time-frame, as trading against the trend is usually not a wise thing to do. So, to take an example, you can see a clear up-trend on the chart below with the 200-day MA rising all along.

The simplest strategy is to go long when the price crosses above the rising moving average, and sell the position when it crosses below it (this works of course with a declining MA and a short position, but with the price crossing below the MA).

Moving Average Strategy 1.

2.     Compare two different MAs for determining the trend and reversals.

The second, and probably the most popular strategy for moving averages is the so-called “cross-over” strategy.  The steps are similar to the first strategy; just instead of the price, you use a short-term MA as the “trigger” for the trades, as you can see it on the chart below. A lot of traders use the additional condition that the long-term average must be advancing for this strategy.

Moving Average Strategy 2.

3.     Identify pullbacks to enter trends more precisely.

This approach the most advanced of these simple strategies and it can be helpful to capture a larger portion of market “swings” than the two prior frameworks. The idea is to take the conditions of the first or the second strategy but wait for a pullback before actually entering the trade.

But what does a pullback mean? Well, that depends on the interpretation, but the basic definition is for the price to touch the given MA in the case of the first strategy. As for the second strategy, a useful way of defining a pullback is to wait for the price retrace to between the short and the long-term MA, just as you can see it on the chart below. This way you will enter to an already established trend with the additional benefit of not getting in a short-term overbought position.

Moving Average Strategy 3.

When does it work?

As it is the case with every indicator, moving averages have their strengths and weaknesses. By knowing when to use these very useful indicators you can avoid the common mistakes that traders make. The most important thing is that MAs work the best in trending markets.

On the contrary, in sideways price action, these averages can give false entries or cause overtrading through too frequent signals. Applying the direction of a longer-term MA as a condition (for example having a rising long-term MA as a requirement for long positions) can be helpful to prevent these problems.

Also, it’s wise to wait for confirmation before entering a trade. As an example, if you are entering a trade using the first strategy, wait for the second close above (or below for a short position) the MA before “pulling the trigger”. This way you can steer clear of “price-spikes” that are an integral part of the forex and cryptocurrency markets.

Featured Image from Shutterstock

Important: Never invest money you can't afford to lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here.



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1 Comment

  1. rtacconi

    September 28, 2017 at 5:06 pm

    Thanks. I would like to see more articles (MACD, RSI…) like this one.

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Trading 101

Trading 101: 7 Trading Mistakes to Stop Making Right Now

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There are a lot of beginner mistakes when it comes to trading and investing. Almost everyone makes them, and for some it takes years to learn the lesson (those that are not serious about the game sometimes never learn it). If you are a beginning trader yourself, learning these lessons can potentially save you a lot of money and frustration on your journey to becoming a profitable trader.

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1. Trying to catch a falling knife 

Don’t buy something just because it has fallen a lot. You need to wait for confirmation from the market that the trend has changed. This confirmation should come in the form of price breaking through a moving average, an inverse head & shoulder pattern, or another move in the price that can easily and objectively be identified.

2. Holding on to positions that are annoying you

If have ever made a bad investment, you probably know how easy it is to hold on to your position despite it falling and falling. Your mind is telling you that it’s just about to turn around, and you promise yourself to sell as soon as you are break-even again… You are now on a sure path to getting eaten alive by better traders than you. The only way to deal with this problem is to ask yourself “would I have bought this position again now or would I rather spend the money on something else?” If the answer is “no, I would not buy it today,” get rid of your position immediately.

3. Buying on rumors or recommendations from friends 

It’s not difficult to find trading recommendations, we even publish them here on Hacked! Feel free to read them all and treat them as input when you are making your own trading decisions. After all, it’s your money on the line. You never know if the person giving you a recommendation is investing money himself or not. If you are going to follow someone else’s recommendations, you should also know their time frame, stop-loss, target price, and how much of total trading capital should be allocated to the trade.

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4. Being nervous about your trades

If you open positions in the market keep you up at night, you are either trading with too much capital or you are not confident enough in your trade. If the risk is keeping you up, reduce your trading size. If you are not confident about your trade, get rid of it and wait for a better opportunity.

5. Don’t focus on profit & loss

Being overly focused on profit and loss in terms of monetary value is a sure way to set the wrong stop-loss or miss an opportunity to ride a nice trend. Instead, look for levels in the chart such as supply and demand zones and observe the price action in those areas. Personally, I like to tighten my stop-loss when the price approaches such a level. That way, you will be able to continue riding the trend if price shoots through the level, and protect your downside if it doesn’t.

6. Hope is no trading strategy

If you’re telling yourself “I hope this one will skyrocket,” you are gambling, not trading. You would be better off taking a trip to the casino, which at least provides some entertainment value. You have to be able to say, “I expect this to skyrocket because…”

7. Panic is no trading strategy either

This one is more for longer-term investors. Whenever there is panic in the markets, you either need to sell very fast or chances are the market has already bottomed out. If you are a long-term investor, just as a trader, you should have a pre-determined plan for when to sell (or not sell at all) should panic erupt. That way, you know what to do when everyone else is panicking and chances are you will come out a whole lot wealthier than the rest of the crowd.

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Trading 101

Why I Switched to Momentum Investing

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Momentum investing

After sticking to various reversal trading strategies for a while now, I have started to look more into momentum and trend when it comes to investing in stocks specifically. Some people may find the idea of momentum a bit strange to begin with, and it is only after watching individual stocks, while also keeping an eye on the movements of the overall market, that you rally understand its meaning.

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Seasoned stock investors, especially those that adhere to value investing, are often skeptical towards the idea of buying a stock that has already increased in price. It basically goes against their instincts of buying low and selling high. However, as people start to understand the mechanics of it, they tend to change their opinion.

Never catch a falling knife

An unwritten law in any market is that a trend tends to continue. Hence, if a stock has been moving up three straight months, it is more likely that it will continue to move up for a fourth month instead of turning down. A “cheap” stock can always become cheaper and an “expensive” stock can always become more expensive. These are well-known principles that explain the basics behind why momentum and trend trading works, and it is the idea behind old cliché’s like “never catch a falling knife” and “cut your losses, let your profits run.”

Over time, however, any financial asset has a tendency to revert to its mean. As such, when a trend has been overextended, a reversal in price can be expected to follow. This is the idea behind reversal trading. However, it is important to understand that it can take a while for this to happen, and you may very well get wiped out in the process.

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The trend is your friend

The concept of buying stocks on their way up makes a lot of sense from this perspective, as you are then buying something that the market is starting to like, which is about to be valued higher. Trying to catch the falling knives is simply to risky from a risk:reward perspective, and in my opinion it should be avoided altogether. Why would you buy a stock that is falling when you instead can buy it at its way up?

Still, there are situations that arise in the grey areas, where a stock seems to have gone so low that it can do nothing but go up again. It may be tempting to give it a try, but remember that this is an extremely difficult thing to do, and the stock may just as well continue its steady decline. When the stock finally turns, there will still be plenty of time for you to jump on the bandwagon.

Mining companies, some companies within the maritime shipping industry, and the entire Japanese stock market are all examples of great bargains from a value standpoint, where the investor would sometimes have to wait for decades to earn his initial investment back. Don’t fall into this trap by picking stocks that are still falling and appear “cheap.” Don’t try to outsmart the market.

Combining momentum with value

Value investing

In my opinion, a killer long-term strategy in the stock market is to combine sound value-investing principles with momentum. In other words, you should look for undervalued companies that have been badly beaten up for years, and that are just starting to turn. Oftentimes, this is where the greatest potential is and I believe it is one of the best ways to beat the index over the long term.

We can find two examples of how well value investing with momentum works in the US after the stock market crashes in the mid-70s and the 2008 financial crisis. Following these two events, only value investing yielded a clearly higher return than value combined with momentum.

However, if you were a value investor before the crash started, chances are you would get wiped out before the market finally turned. If, on the other hand, you were a value investor with momentum as one of your criteria for holding, you would automatically get rid of all the stocks that were in decline, and instead buy them again after the crash was over.

Because of this, momentum indicators like the MACD can be of great help when making these investment decisions. When combined with value-principles, you have a killer approach to long-term success in the stock market. I’m definitely looking more into crafting a robust investment strategy based on this for myself, and I will come back and share more specifics on potential strategies later.

Featured image from Pixabay.

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Trading 101

Trading 101: Intro to Forex Trading

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Forex trading

When you are first getting introduced to the world of forex trading, things can seem a bit overwhelming. There is so much information available online, but very little of it is aimed at beginners who may not be familiar with the terms and concepts they refer to. In this article we will cover the basics of forex trading, explain the most important terminology, and tell you how you can get started trading forex for yourself.

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Forex jargon

To start off, let’s define some terms. Forex stands for “Foreign exchange” and is the name often used for this market where traders can buy one currency by paying with another currency. Other names used for this is the “FX market” or the “currency market.”

A pip, often referred to as “point in price”, is simply the smallest price move that is possible in a given currency, also known as a basis point. Forex traders often talk about their gains and losses in terms of pips instead of percentages or monetary values.

Long/short are confusing terms that often get tossed around by forex traders as well as other traders. To put it simply, long means that you are buying an asset and will make a profit if that asset goes up in price. Short, on the other hand, means that you are trying to make a profit from declining prices. The way it works is that you sell an asset that is borrowed from another market participant. After the price has dropped, you can then buy back the asset in the market for a lower price than you sold it for, and thus make a profit.

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Stop-loss is the level a trader decides on where he would like to exit his trade if it is not working out for him. In other words, it is the maximum loss the trader is willing to take on one particular trade. Alternatively, a stop-loss order can be used to secure a profit on a profitable trade in case the market turns.

Leverage is the practice of taking a larger position in the market than your trading account size would otherwise allow. Basically you are borrowing money from your broker in order to boost your buying power in the market. Leverage offered in the forex market is often in the range of 200-400:1

Spread, also known as bid-ask spread, is the difference between the buying and selling price of an asset in the market. The broker will offer you to buy a currency at a slightly higher price than they will let you sell that currency. This is where brokers make most of their money, and it is important to compare spreads when choosing a forex broker.

Currency pairs

Since the forex market works by participants buying one currency with another currency, the price of a currency must always be quoted in another currency. For example, when you see that EUR/USD is trading at 1.20, it means that you need 1.20 US dollar to buy 1 euro.

The worlds largest market

The forex market is known as the largest of the world’s financial markets. Approximately $5 trillion changes hands in the forex market every day, far surpassing the global stock markets and commodities markets.

It is important to understand that the trading activity that retail traders (traders like you and me) account for is just a small, but rapidly growing, share of the total activity in the forex market.

Fundamental or Technical Analysis

When you are deciding to become a trader, you also need to decide on what type of trader you want to be. Broadly speaking, there are three types of traders; fundamental traders, technical traders, or a combination of the two.

Fundamentals take into account news, valuation, interest rates, etc. when trying to determine what price a currency pair “should” be trading at.

Technicals, on the other hand, focus strictly on what the price of the currency pair is doing. Technical traders study and analyze price charts to try to determine the future direction of the price.

Majors and Minors

Forex traders often talk about majors and minors when referring to currencies. Majors is a list of the most actively traded currency pairs in the world, and it consists of these pairs:

  • EUR/USD: The euro and the US dollar.
  • USD/JPY: The US dollar and the Japanese yen.
  • GBP/USD: The British pound and the US dollar.
  • USD/CHF: The US dollar and the Swiss franc.

Forex majors often have the lowest spreads in the forex market and they are also among the most liquid instruments you can trade in the financial markets.

Forex minors is a list of the next most actively traded currencies. This list includes currencies such as the British pound (GBP), Canadian dollar (CAD, aka “Loonie”), Australian dollar (AUD, aka “Aussie”), and New Zealand dollar (NZD, aka “Kiwi”).

Lastly, there are the exotic currency pairs. These include the remaining currencies from European countries outside the Eurozone (NOK, SEK, DKK) and smaller yet important Asian currencies like the Singapore dollar (SGD) and Hong Kong dollar (HKD). The exotics have less trading activity and the spreads are usually higher than for the majors and minors.

Benefits of Forex Trading vs. Stock Trading

A benefit of trading in the forex market rather than the stock market is that the forex market is trading 24 hours a day, from Monday morning in Australia until Friday evening in North America. The great thing about the market being open 24 hours is that there are no overnight “gaps” like you can find in the stock market.

A gap simply means that the market opens at another price in the morning than it closed the night before. For traders, gaps are considered a big risk, since the trader cannot control what is happening with his trade while the market is closed.

A market that is open 24/5, like the forex market is, opens up great opportunities for medium-term traders (swing traders) to for example take positions during the beginning of the week and exit those same positions before the week is over. That way, the trader takes no risk over the weekend when the market is closed.

Additionally, the forex market is much more liquid than most stocks, and it’s easy to find technical and fundamental analysis of this market everywhere on the Internet.

Choose a Forex Broker

Once you have decided to give forex trading a try, you need to choose a good broker that you trust with your money. This is the first, but still a critical step, on your way to become a successful trader. Pay particularly close attention to regulation, withdrawal policies, spreads, and trading platforms offered when choosing your broker. Fore more on this, read our earlier article on how to choose a forex broker.

Featured image from Pixabay.

Important: Never invest money you can't afford to lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here.



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