What Is the 20-Day Simple Moving Average? And How Does It Work?

Introduction to the 20-Day Moving Average

Active traders rely heavily on technical analysis indicators to guide their entry and exit strategies. 

And the 20-day moving average is one of most popular indicators used by day and swing traders. In fact, it might be the second best-known indicator behind the 50 day moving average.

If you've been wondering how to make the most of the 20 day, you’re on the right page. 

Because you’re going to:

• Understand the definition of the 20-day moving average
• Why it’s so popular
• Pros and Cons
• How to use the 20 day to improve your trading

Definition of the 20-Day Moving Average

First things first—what exactly is a moving average? 

A moving average is a statistical calculation that smooths out price data by averaging the closing prices of a stock, index, or ETF. Moving averages can be used on every time frame ranging from minutes to years. But for the purposes of this article, we will focus on the daily time frame.

The 20 day-moving average is the average of the most recent 20 closing prices.

It is also called the 20-day simple moving average (or 20 day SMA).

Wy simple? Because it’s a straight average.

The moving average is plotted as a line on a stock chart to help you understand the current trend.

Here’s an example of JP Morgan (JPM) with its 20-day moving average.

Why Is It Called a Moving Average?

It’s called a moving average because it’s moving.

At the end of each trading day, the oldest closing price in the moving average is removed to make room for the newest closing price.

Simple vs. Exponential Moving Averages

As you learned just above, a simple moving average is just a straight average.

There is another kind - the exponential moving average, also known as an EMA.

An Exponential Moving Average (also known as an EMA) is a type of moving average that uses a calculation more heavily weighted towards recent price action.

As you can see on this chart of AMC (AMC), the 20-day exponential moving average line is closer to the current stock price than the 20-day simple moving average line.

Why the 20-Day Moving Average is Popular

Easy to Understand, Easy to Access

Perhaps the biggest reasons the 20 day is popular is ease of use and access.

Since the calculation is so simple, even the freshest beginners understand the 20 day.

And it’s easy to access because every trading platform on Earth includes the 20 day as an option.

Even free services like Yahoo! Finance offer the 20 day as an indicator.

Quick Responsiveness

The shorter the time frame, the quicker a moving average responds to recent price changes.

So the 20-day moving average does a good job of capturing the short-term trend.

That’s why it’s so closely watched by swing traders, who commonly use daily charts to find new trading opportunities.

Versatility

While we are covering the 20-day moving average in this article, you can adapt it to other time frames.

For example, day traders may use time frames like the 5 minute chart, where the 20 ma would encompass the price action of the 20 most recent 5-minute bars.

And long-term investors may find value in the 20-week or even 20-month moving average.

Pros of Using the 20-Day Moving Average

Quick to React

Unlike its longer-term counterparts such as the 50-Day or 200-Day Moving Averages, the 20-Day SMA is quick to incorporate new data. 

This makes it valuable for traders looking for clues on potential trend changes.

As you can see in this chart of Adobe (ADBE) , the 20 day more closely tracked the short-term trend than the 50 or 200. Ease of Use

The 20-Day Moving Average isn't a complicated indicator like MACD.

It's among the easiest indicators to understand.

Identifying Short-Term Support and Resistance

A unique feature of moving averages is their ability to act as potential support for a falling stock, or resistance for a rising stock.

The 20-Day SMA frequently serves this purpose for short-term traders, potentially helping to identify entry and exit points.

Here is a chart of Activision Blizzard (ATVI) showing the 20-Day SMA serving as support during a powerful uptrend for the stock:

Cons of Using the 20-Day Moving Average

Prone to False Signals

The downside of being quick to react to price changes is that the 20-Day SMA is susceptible to false signals. 

A stock price can surge through the 20-Day SMA, making you think a new uptrend is starting.

But it can reverse easily. 

In this chart, you can see Oracle (ORCL) accelerated over its 20-day moving average, but it quickly reversed back below:

Limited Long-Term Insights

If you're a trader more interested in the long-term game, the 20-Day SMA may offer you limited utility.

That’s because it’s designed for capturing short-term trends and is less useful for long-term market analysis.

How to Use the 20-Day Moving Average in Trading

Signal Generation

Typically, a stock price crossing above its 20-Day Moving Average could be seen as a potential buying opportunity, while crossing below may suggest the stock will drop. 

However, real trading is never that simple, so you must look for confirmations from other indicators.

SMA Crossovers

When the 20-Day SMA crosses above a longer-term moving average like the 50-Day or 200-Day SMA, it's sometimes considered a bullish signal. 

Nvidia's (NVDA) massive 2023 rally kicked off when the 20-day moving average crossed over the 50-day:

Conversely, a cross below the long-term moving average can be a bearish signal. 

These crossovers can help traders identify significant trend reversals, and should be on your radar.

Risk Management

Some traders may set their stop-loss orders around the 20-Day SMA line. 

For instance, if you are in a long swing trade, you might consider setting a stop-loss order slightly below the 20-Day SMA to mitigate downside risk.

Confirmation with Other Indicators

For a more robust trading strategy, the 20-Day Moving Average should be used in tandem with other indicators like the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD) for more reliable signal interpretation.

Conclusion

The 20-Day Moving Average is a versatile and responsive tool for traders looking to understand short-term stock and market movements. While it has its limitations, particularly its susceptibility to false signals, its advantages—speed, simplicity, and the ability to identify short-term support and resistance—make it a must-have in any day or swing trader's toolkit.

Like any other trading tool, the 20-Day SMA is not a comprehensive trading strategy in and of itself. You must combine it with other indicators and tools to give yourself the highest chances of success. 

But either way, keeping the 20-Day SMA on your charts gives you a fast and accurate read on the short-term trend.   

Good luck out there!

To Learn More About Moving Averages

If you’d like to get a better understanding of how moving averages can be used to find winning trade ideas, check out Scott Redler’s free eBook “The Ultimate Guide to Moving Averages.”