Moving Averages: The Foundation of Your Investment Strategy
Hi Readers , Today let’s take a look at some theory on the daily moving averages and then delve in to the practical ways to make profitable trades.
Types of Daily Moving Averages ( Not limited to )
- Simple Moving Average (SMA): SMA calculates the average price of an asset over a specific period. It’s a basic form of DMA and changes constantly with new price data. Backtesting has shown that SMAs are less effective in consolidating markets and produce most of their losses in such conditions. The SMA’s win rate, compared to a buy-and-hold strategy, is generally low, around 12% for a 20-day period.
- Exponential Moving Average (EMA): The EMA places more emphasis on recent price data, making it more responsive to short-term price changes. EMAs are particularly useful for short-term trading strategies. However, they can provide false signals in volatile markets and are less reliable for long-term trend identification.
- Weighted Moving Average (WMA) and Hull Moving Average (HMA): These are more complex DMAs that give more weight to recent prices. The Hull Moving Average, for instance, is known for its ability to reduce lag and respond quickly to market changes. It’s shown promise in both mean-reversion and trend-following strategies.
Moving Average Strategies ( Context driven , not generic )
- Triple Moving Average Crossover: This strategy involves using three DMAs with different periods. It generates early buy or sell signals at the start or end of a trend. The combination of these averages helps in reducing false signals.
- Using DMAs for Trend Following: DMAs can be instrumental in identifying the beginning stages of a trend, which typically offer the highest reward-to-risk ratio. Longer DMAs help identify long-term trends, while shorter ones provide early signals for market entry and exit.
- Setting Stop Losses and Taking Profits: DMAs can also be used to set stop losses and take profits, thereby protecting your investment. For instance, placing a stop-loss order just above the DMA during a downtrend can minimize losses.
DMA – Applications for systematic acquisition
Example 1 :
Stock Choice: Fundamental Strong and has historical background at least 10 years.
Black: Daily Simple Moving Average 200 Days (DMA 200)
Red : Daily Simple Moving Average 50 Days (DMA 50)
Buy Zone 1 : When the Stocks trades below black line
Buy Zone 2 : When the Stock trades below Read lines.
Take Away :
This is your averaging strategy at lower levels.Assuming the average price of your acquisition is around 200 Per share by the time of writing this article the CMP is range of 360 meaning 80% in span of 18-20 Months by acquiring systematically using moving averages.Let’s take a look at TATA POWER stocks and how understanding of the moving averages will help you in maximizing your profits:
Example 2 :
Stock Choice: BANKBEE ETF is a basket of Bank stocks and indeed fundamentally superior of all instruments.
Let’s take a look at another example on BANKBEES
Take Away :
As you take look at below , BANKBEES traded below DAM200 at 436 levels and a SELL opportunity at resitane line depicted in red line around 491 levels giving 12% returns in span of 4 months.
Interestingly , now that BANKBEE is providing another BUY opportunity as per latest chart
( Buy Zone 2)
Limitations and Considerations
- DMAs are less effective in consolidating or range-bound markets.
- They require continuous adjustment and monitoring, especially in volatile conditions.
- The choice between SMA and EMA depends on your trading style and the time frame you are analyzing.
- DMAs should be used in combination with other indicators for more reliable decision-making
Cheers
Srikanth
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