Moving averages are one of the most important technical analysis tools I use. They help me figure out:
I rate moving averages above news, economic data, earnings, and just about any indicator you can think of.
If I was a starting trader looking to build my net worth, moving averages would be my #1 focus.
And through a series of new case studies, you will learn:
Editor's Notes: If you want even more moving average case studies, please check out The Ultimate Guide to Moving Averages.
Positions Disclosure: at the time of writing, Scott was long MBIO, SPY puts; was short SPY calls, SPY puts
What Is a Moving Average? And How Are They Calculated
Let's talk about how moving averages are calculated.
A moving average is a stock's average price over a specific time period.
A daily moving average is the average of a stock's daily closing prices over a specified number of days.
(a weekly moving average would be the average of a stock's weekly closing prices over a specified number of weeks)
We'll focus on the daily time frame in this guide.
For example, the 50 day moving average is a stock's average closing price for the last 50 days.
Every day, the newest closing price in the moving average replaces the oldest, which is why we call it 'moving' -- a moving average change every day.
Here's a simple chart of Apple (AAPL) with its 50 day moving average.
The Biggest Myth About Moving Averages
People often say "moving averages don't work" or "everyone sees the same moving averages, so they have no value"
But here's the reality: most serious technical analysts understand that a moving average is not the same as a trading strategy or even a signal.
I don't buy and sell purely because of a moving average.
But moving averages do help me understand the trend which contributes to my overall decision-making process.
That's why they're so valuable to me.
Simple vs. Exponential Moving Averages
There are 2 types of moving averages -- simple and exponential.
They are calculated in slightly different ways.
A simple moving average is exactly what it sounds like -- a simple average of the stock price. (the closing stock price, specifically)
An exponential moving average gives extra weight to recent prices, so it does a better job of measuring the near-term trend.
Here's Advanced Micro Devices (AMD) with its 50 day simple (blue) and exponential (pink) moving averages.
They're pretty close, but the exponential (pink) is closer to the current price.
The Moving Averages I Use
Technicians and traders have tended to focus on the 10, 20, 50, and 200 day simple moving averages, which you can think of as follows:
10 day simple moving average: very short-term trend
20 day simple moving average: short-term trend
50 day simple moving average: intermediate trend
200 day simple moving average: long-term trend
I use a slightly different set of moving averages in my own trading, and in Redler All-Access:
8 day exponential moving average: very short-term trend
21 day exponential moving average: short term trend
50 day exponential moving average: intermediate trend
200 exponential moving average: long-term trend
(I matched the colors here on the charts below.)
I use exponential moving averages because they are more sensitive to the recent action, which gives me a better read on the near-term trend.
Going forward in this article, all moving averages are exponential.
Is There a Difference Between an 8 and 10 Day Moving Average?
You may be asking "why the 8 day moving average? Why not the 10 day?"
Most of the time, they'll be very close together, as shown in this Amazon (AMZN) chart:
But here's what most people miss about moving averages:
It's not the exact moving averages you use that counts.
It's how well you use those moving averages to find opportunities, avoid trouble, and manage risk.
I pay most attention to the 8 and 21 day exponential moving averages.
I stick with those because my brain is trained to judge the action based on those time frames.
If I was using, say, the 10 and 20 day simple moving averages, I'd probably end up with the same results -- I'd just get there in a slightly different way.
The Power of the 8 & 21 Day Exponential Moving Averages
Traders often ask me why I talk about the 8 & 21 day exponential moving averages so much.
Whether you see me on Fox Business, CNBC, Twitter, or the Virtual Trading Floor®, odds are you'll hear me me talking about them.
Stocks that are in uptrends find support at the 8/21/50day. Stocks in downtrends get rejected at them on Bounces. Below the 200day is real selling. Rules to live by
— Scott Redler (@RedDogT3) November 14, 2018
It's because these moving averages are the most accurate short-term road map I've found.
And I value moving average more than any other analysis I see out there.
8 & 21 Day Moving Average Case Study I: The Energy Sector
From the 2020 pandemic low to the time I'm writing this (October 2022), the energy sector dominated the market.
Here is a chart of the VanEck Oil Services ETF (OIH) from December 2021 to March 2022 with the 8 and 21 day exponential moving averages.
As you can see, the moving averages are sloping up. What were they telling us?
They were telling us the trend was strong.
As you can see, OIH just trended up along the moving averages, with occasional breaks that were quickly reclaimed.
This is a classic powerful uptrend.
Even if you're not long a stock or ETF like this, resist the urge to short. Remember, the trend can go a lot further than may seem reasonable. In this case, OIH was rising because the Ukraine war spiked energy prices.
If something goes from $200 to $300+ while staying above the 8 & 21 day moving averages, don't bet against it going higher.
So I never, ever short stocks or ETFs that show momentum above the 8 & 21 day moving averages.
NEVER short a stock that shows momentum above the 8 & 21 day moving averages - @reddogt3
8 & 21 Day Moving Average Case Study II: Pandemic Play Peloton (PTON)
Stocks fell hard in early 2020 because of the Covid-19 pandemic. But after the March 2020 bottom, the market ramped hard.
And "stay at home/work from home" stocks like Zoom (ZM), Teladoc (TDOC), Docusign (DOCU), Apple (AAPL), and Nvidia (NVDA) were on fire.
So was Peloton (PTON), which turned into a huge win for me.
By every possible measure, Peloton was expensive and in many cases it felt overbought.
But it refused to break the 8 and 21 day moving averages.
That meant the trend was strong.
Every short should have asked themselves "am I right about the fundamentals, but wrong on the stock?"
This is why moving averages and trend analysis are so important -- you know when your opinion is about to cost you $50,000.
8 & 21 Day Moving Average Case Study III: The SPY Post-Brexit Classic
Let's rewind the clock back to the Brexit in June 2016.
I've shown this case studies in several webinars and training events, and I bet I'll be teaching it 10 years from now.
The day before the Brexit vote, the SPY hit $210.87.
And the day after the 'shocking' vote, it hit $188.65.
If you were focused on headlines like this, you were probably feeling pretty scared:
But let's extend the chart to see what actually happened.
As you can see, SPY started bouncing, and on June 30, 2016, it reclaimed the 8 & 21 day moving averages:
That's a sign of strength, not weakness.
Why?
Because momentum was shifting back to the upside. The news was either priced in or not as bad as expected.
SPY briefly retested the 8 & 21 day moving averages before rallying above $219:
Everyone had an opinion over what Brexit would mean.
But as you just saw in the charts, the market didn't care about anyone's opinions.
When SPY reclaimed the 8 & 21 day moving averages with authority, the bulls retook control.
Any bears that stood in the way got steamrolled.
And that's an important lesson: when a stock/index/ETF reclaims the 8 & 21 day moving averages with authority, PAY ATTENTION!
When a stock reclaims the 8 & 21 day MA's with authority, PAY ATTENTION! - @reddogt3
How I Use the 8 & 21 Day Moving Averages to Manage My Market Exposure
You just saw how a trend above the 8 & 21 day moving averages can signal higher prices.
Now let me show you how I use the 8 & 21 day moving averages to reduce risk or even short.
I have two primary approaches to the market: a Portfolio Approach and a Tactical Approach
When the SPY is trending above the 8 & 21 day moving averages, I am in what I call a Portfolio Approach. I'll hold as many as 30 individual stocks showing relative strength, plus options positions.
When the SPY breaks the 8 & 21 day moving averages, I get in a Tactical Approach.
I start taking profits, I put on short hedges, and I keep a close eye on the exits.
Portfolio Approach
Tactical Approach
Here's a chart of the SPY with its 8 & 21 day moving averages:
As you can see, it reclaimed the 8 & 21 day moving averages with a big gap up that held.
After that happened, would it be better to be long multiple stocks showing relative strength? Or short the market?
Obviously, it was better to be long.
The lesson: if SPY breaks above the 8 & 21 day moving averages, pay attention! The market could be on the verge of a powerful trend change.
How I Use the 50 Day Moving Average
If a stock (or an index or ETF) loses the 8 & 21 day, I look next to the 50 day.
As I noted before, I use the 50 day average to judge the intermediate trend.
In other words, I watch to see if a stock is heading down to no man's land around the 200 day (bad), or rebounding back up to test the 8 & 21 day (good).
As I noted before, I use the 50 day average to judge the intermediate trend.
50 Day Moving Average Case Study: COIN
Coinbase (COIN) was a prime beneficiary of the post-Pandemic crypto boom. But as you can see on the chart, the party did not last.
Coinbase hit a high of $368.90 on November 9, 2021.
Then, it broke the 8 & 21 day moving averages at $325, which was a major sign of trouble.
Then it lost the 50 day at $301, showing that the intermediate trend was broken.
It only got worse from there - showing you why you can't just sit back when stocks break key moving averages.
How I Use the 200 Day Moving Average
The 200 day moving average also plays an important role in my stock selection process.
If a stock is below the 200 day, I avoid using it for swing trades.
I'll only scalp them long and short.
This is because names under the 200 day are technically broken, and hard to trust.
Once a stock or ETF loses the 200 day, there is no telling how far it could fall.
I circled each break under the 200 day. In mid-to-late 2018, each break of the 200 day resulted in a lower low.
And then in early 2019, we finally saw a real failure, and Tesla dropped by $100+.
I avoid stocks like this for swing trades because they're not worth my time. There are so many stocks that are easier to trade, so why bother?
200 Day Moving Average Case Study: AMD
Look at Advanced Micro Devices (AMD), which has been in a downtrend for most of 2022.
As you can see, it repeatedly failed to reclaim the 200 day, and just kept falling.
So could you have made money scalping it short-term?
Yes. But holding on would have cost you big.
Thanks for Reading!
I hope this in-depth lesson gave you some valuable insights on how I view price action.
Now I have a challenge for you.
Take a major event like a Fed decision, election results military conflict, or major market downturn.
See how the SPX acted around the 8, 21, 50, and 200 day moving averages both before and after the event.
This will teach you to start focusing on levels instead of getting locked into opinions.
It feels good to be right about the news. But it feels better to make money because you were right about price.
