Trade Better With Simple Moving Averages

February is finally behind us, and I say good riddance.

For the last 100 years, February has plagued investors with flat or negative returns. To be fair, it’s a great month to add to existing positions as stock prices decline – but it’s also often volatile.

March, on the other hand, is a month the bulls can get excited about.

According to Bespoke Investment Group, the Dow Jones Industrial Average (DIA) has gained an average of 1.36% in March over the last 20 years.

To capture this trend, we can use one of the simplest yet most powerful tools in any trader’s kit.

Keeping It Simple

When setting up a new stock trade, one of the first steps is identifying the trend – is a stock moving up, down, or sideways?

The last thing anyone wants to do is buy a stock ahead of a steep fall – or, worse yet, short a stock before a major rally.

Using a stock’s simple moving average (SMA) – the sum of a stock’s closing prices over a set number of periods, divided by the number of periods – is a quick and easy way to help you determine a stock’s direction.

It’s a mouthful, but you’ll likely never have to do the calculation manually. Nearly every trading website and brokerage program that charts financial data will do all the work for you.

We say this average “moves” because as time passes, an old period is dropped from the calculation and a new one is added.

Powerful and Versatile

In general, the shorter the average, the tighter and more sensitive it will be to a stock’s price.

Conversely, longer averages are smoother, as they’re less sensitive to short-term spikes and dips. On daily charts, some commonly used short-term averages include the 4-, 5-, 10-, and 20-day SMAs. Popular long-term averages are the 50-, 100-, and 200-day moving averages.

At a very basic level, a moving average can tell you in which direction a stock is trending. These averages can also act as support and resistance levels.