Stocks Trading Lesson 4 – Strategy 1 Direction of the Moving Average

Now that you have an account setup we need some base trading strategy. This strategy can work in any time frame, for the purpose of discussion lets assume this is a daily graph of company XYZ (symbol XYZ).



The line in black is the actual daily price almost in zigzag fashion as you would see chart of any stock. The line in red is the moving average. The x-axis are the days (or any time frame e.g. hours) from left to right, and y-axis is the price of the stock.

Moving Average
Moving average is drawn using the last n points (e.g. closing price) and dividing by n. For each day the last n points (e.g. last 50 days price) is used to compute the price on the graph. The net affect is a smooth graph whose underlying data is the actual stock prices.

Choosing Moving Average
Moving average is based on number of days to use to lookup back to compute the average for every bar (bar means daily bar in our case). The longer the lookback time the slowly it will change. A 50 to 100 bar moving average is a good choice.

The Strategy to Buy
Buy when the angle of the red line relative to x-axis is greater than 0 i.e. the line has steered “up”

The Strategy to Sell
Sell when the angle of red line has less than 0 relative to x-axis i.e. when the direction or the line has started to “bend” towards the bottom.

This strategy is simple and profound. When the angle of the curve changes it means the “slow” curve is convinced that the trend has changed. On a daily graph for example it could take months or weeks before a curve changes direction. The longer the moving average duration is the more convincing this curve tells you the long term trend. Always trade in the direction of the trend.

Tip. This simple trading strategy can be applied even to your long term investments e.g. 401 or IRA accounts. Simple look at the graph of S&P or DOW and look at the 100 day moving average. If the angle is positive i.e. upwards stay invested in stocks. If the angle turns downwards start moving your assets into “safer” class.