Day traders need continuous feedback on short-term price action to make lightning-fast buy and sell decisions. Intraday bars wrapped in multiple moving averages serve this purpose, allowing quick analysis that highlights current risks (as well as the most advantageous entries and exits). These averages work as macro filters as well, telling the observant trader the best times to stand aside and wait for more favorable conditions.
Choosing the right moving averages adds reliability to all technically-based day trading strategies, while poor or misaligned settings undermine otherwise profitable approaches. In most cases, identical settings will work in all short-term time frames, allowing the trader to make needed adjustments through the chart's length alone.
Given this uniformity, an identical set of moving averages will work for scalping techniques—as well as for buying in the morning and selling in the afternoon. The trader reacts to different holding periods using the charting length alone, with scalpers focusing on one-minute charts, while traditional day traders examine five-minute and 15-minute charts. This process even extends into overnight holds, allowing swing traders to use those averages on a 60-minute chart.
Key Takeaways
- Moving averages add reliability to all technically-based day trading strategies and, in most cases, identical settings will work in all short-term time frames.
- Five, eight, and 13-bar simple moving averages (SMAs) offer relatively strong inputs for day traders seeking an edge in trading the market from both the long and short sides.
- Moving averages work as macro filters as well, telling the observant trader the best times to stand aside and wait for more favorable conditions.
5-8-13 Moving Averages
The combination of five, eight, and 13-bar simple moving averages (SMAs) offers a relatively strong fit for day trading strategies. These are Fibonacci-tuned settings that have withstood the test of time, but interpretive skills are required to use the settings appropriately. It's a visual process—examining relative relationships between moving averages and price—as well as moving average slopes that reflect subtle shifts in short-term momentum.
Increases in observed momentum offer buying opportunities for day traders, while decreases in momentum may signal timely exits. Decreases that trigger bearish moving average crossovers in multiple time frames offer short saleopportunities, with profitable sales covered when moving averages start to turn higher. The process also identifies sideways markets, telling the day trader to stand aside when intraday trending is weak and profitable opportunities are limited.
Examples Using Moving Averages
:max_bytes(150000):strip_icc()/QQQ_ARelativelyStrongMovingAverageCombinationforDayTrading-f6ee3f6094204566a4b1705ab8728457.png "The Perfect Moving Averages for Day Trading (1)")
Invesco QQ Trust (QQQ), signaled a trend reversal using the 5-8-13 bar SMAs, as illustrated in (A) in the line chart above. Later on during the trading session, around the lunch hour, there was a test of the uptrend as seen in (B). The test did not result in a reversal and the ETF continued to rise
towards the mid-afternoon trading session.
At (C), the 5-8-13 bar SMAs signaled a pause in trend. This lasted until the end of the trading session. At the new trading session, (D), the uptrend resumed until another pause occurred at (E) during the lunch hour.
The first leg of the uptrend, (A) to (C), lasted 51, 5 minute bars and generated 2.59 points or 0.79%, without adding spreads and commissions. The second leg of the uptrend, (D) to (E), lasted 35 bars and created 2.64 points or 0.8%, without adding spreads and commissions.
Signals to Stand Aside
Interrelationships between price and moving averages also signal periods of adverse opportunity-cost when speculative capital should be preserved. Trend-less markets and periods of high volatility will force five, eight, and 13-bar SMAs into large-scale whipsaws, with horizontal orientation and frequent crossovers telling observant traders to sit on their hands.
Trading ranges expand in volatile markets and contract in trend-less markets. In both cases, moving averages will show similar characteristics that advise caution with day trading positions. These defensive attributes should be committed to memory and utilized as an overriding filter for short-term strategies because they have an outsized impact on the profit and loss statement.
:max_bytes(150000):strip_icc()/QQQ_ARelativelyStrongMovingAverageCombinationforDayTrading_2-10ea64ee60294a4fa1ab2c9b84981742.png "The Perfect Moving Averages for Day Trading (2)")
At (C), QQQ bobs and weaves through an afternoon session in a choppy and volatile pattern, with price whipping back and forth in approximate one-point range. The respective SMAs shows similar whipsaws, with multiple crossovers but little alignment between moving averages. These high noise levels warn the observant day trader to pull up stakes and move on to another security.
What are the Benefits of Using Moving Averages for Day Trading?
Moving averages for day trading are used in trend identification. They help traders identify prevailing trends in the market. Also, moving averages can act as dynamic support and resistance levels.
Another benefit is signal generation. Moving averages can generate trading signals, particularly when different moving averages of varying time periods are used together. Moreover moving averages can confirm price actions and be used for risk management purposes.
What are the Risks and Limitations to Moving Averages in Day Trading?
While moving averages are very useful in day trading, there are risks and limitations to including the indicator in the strategy. One instance is that a moving average is a lagging indicator, it is based on historical data and may not provide timely signals for rapid market changes. Also, moving averages can produce false signals during periods of choppy or range bound markets.
Moving averages lack adaptability. They have fixed parameters such as the time period used for calculations. Another risk is that moving averages are very popular technical analysis indicators and many traders use them, which can lead to herd behavior and self-fulfilling prophecies. Finally, moving averages tend to work best in trending markets, where the price moves in a relatively consistent direction.
Apart from SMAs, what other Type of Moving Averages should be considered in Day Trading?
There are a few other types of moving averages that should be considered in day trading strategies. These include the Exponential Moving Average, Smoothed Moving Average (SMMA), the Triangular Moving Average (TMA) and the Volume Weighted Moving Average (VWMA).
What Other Technical Analysis Indicators can be used for Day Trading?
Day traders tend to use numerous technical analysis indicators. Some include the Relative Strength Index (RSI), the Moving Average Convergence Divergence (MACD) indicator, Bollinger Bands, Stochastic Oscillator, Ichimoku Cloud and the Average True Range (ATR).
Is there a Perfect Set of Moving Averages for Day Trading?
There is no perfect set of moving averages for day trading that universally applies to all traders or market conditions. The choice of moving averages depends on various factors, including the trader's style, timeframes, the asset being traded, and market volatility. It is crucial to experiment and test other moving averages in a trading strategy. Also, combining moving averages with other technical analysis indicators to confirm signals is helpful.
The Bottom Line
There is no perfect set of moving averages. The 5, 8, and 13-bar simple moving averages do offer relatively strong inputs for day traders seeking an edge in trading the market from both the long and short sides. Also, this technique works well as filters, telling fast-fingered market players when risk is too high for intraday entries. Nonetheless, individuals seeking alpha should also consider other simple moving average parameters and even other technical analysis indicators.
