Trader Toolkit: An Essential Indicator For Spotting Trends In Stocks

With more and more trading platforms and the growing allure of low-to-no-fee brokerages, new traders are confronted with a deluge of options when it comes to trading and investing.

But lost in the promises of sleek interfaces and free shares for signing up is the fact that successful trading takes time, practice and an understanding of resources experienced traders use on a daily basis.

With that in mind, we’re going to use this new series of articles to take a look at the charts, ratios, and indicators that play an integral role in how traders generate ideas and form convictions on their medium- or short-term trades. To do that, we’ll be using the charts and tools available on the Webull trading app, which offers traders access to real, zero-commission trading in addition to a suite of advanced trading analysis and charting.

Moving Averages

Among the most heavily relied-upon indicators in all of equity investing, moving averages serve to illustrate how a stock’s current price action compares to its prior behavior over a given time span. Moving averages appear alongside price charts and roughly trace the general trajectory of the stock’s share price, albeit without the moment-to-moment volatility. It is an average, after all.

The average in question is derived from the closing prices of a particular security over a given period of time. The periods can range from 200 days all the way down to the last five closing prices in a trading session. Averaging these periods evens out the jagged edges of moment-to-moment market activity to reveal a potential trend in a stock, with larger time spans intended to smooth out even larger bouts of volatility to arrive at a secular picture of a stock’s performance.

In WeBull’s one-month chart for the Walt Disney Co. DIS, the effect of this averaging becomes clear. Notice how the various moving averages weave around the stock’s price and one another. These intersections are important in-and-of themselves, but for now, just take a look at how each of the lines corresponds to their counterparts.

Source: Webull; Data as of July 16, 2019

The chart’s legend in the top left corner shows the duration of time each line’s averages correspond to and the number of periods each point is averaging out. The blue line representing the average price over trailing five-day span, the orange representing trailing 10-day interval and purple signifying the previous 20-day average. Given the incrementally increasing sample length, it’s easy to see how the day-to-day volatility is ironed out as the span increases.

Long-term traders can use moving averages as a means of gauging when a stock’s price is supported by its historical trajectory, or when it might potentially be entering an extended period of heavy buying or selling, adjusting their portfolios accordingly. Short term traders, on the other hand, might use minute-charts to set entry and exit points on a stock they only plan on holding for a short time.

While different traders might focus specifically on one moving average over another depending on their particular timeframe, most will use the patterns in tandem with one another or as part of another technical indicator like Bollinger bands, which use moving averages to illustrate a stock’s average price range.

The intersection of moving averages can indicate bullish or bearish patterns within a stock’s current price. Among the most easily singled are bullish and bearish crosses, which occur when short- and long-term moving averages intersect. A bullish cross occurs when a stock’s short term moving average rises above its long-term average while a bearish cross is the inverse.

You can see an example of a bullish cross on July 9 in the chart below of Beyond Meat Inc. BYND. The blue 5-day MA crossed above the yellow 10-day MA and purple 20-day MA.

Source: Webull; Data as of July 16, 2019

Moving averages serve as a foundational resource for traders of all levels. They are used and iterated upon in a variety of ways, from exponential moving averages, which place a heavier weight on more recent price action, to Moving Average Convergence Divergence (MACD), a tool that itself deserves a comprehensive breakdown.

One thing to keep in mind about moving averages is that they rely on previous performance and are therefore backward-looking, or lagging, indicators. This means they’re not intended to reflect a dramatic or unexpected change in how a stock is behaving, only the general path it’s tracing based on prior behavior.

However, because the market is largely dictated by patterns, it’s obvious to see why moving averages are a key component to how many new and experienced traders view the market.

Webull is a content partner of Benzinga