Moving averages

Celticheart Investor

A beginner's guide to trading and investing

Moving averages are not in fact a tool as such but just a smoothing out of the average share price activity to form a trend following indicator. 

They do not predict price direction as they are based on past share price so are, by definition, tracking what has already happened. Despite this delay, moving averages help smooth price action and filter out the noise. 

They also form the building blocks for many other technical indicators, such as the Bollinger bands we have already examined (the middle BB is also the EMA 20 line) and MACD (moving average convergence/divergence) which we will be looking at later on. 

The two most common types of moving averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). These moving averages can be used to identify the direction of a trend and are useful in helping to define potential support and resistance levels. It should be noted 
that it is not possible to create an EMA with out starting with an SMA.

Moving averages can be calculated over any given periods but generally 20 day and 50 day increments are used by most chartists. It is how the two periods interact that is most informative for share traders and investors alike.

Although not a strong enough indicator on its own, when the EMA 20 crosses above the EMA 50 it often signals a buy but when the EMA 20 crosses below the EMA 50 this signals a possible sell. Again I would stress that this applies in the main to traders rather than investors as often the fluctuations we are talking about are too small to consider a buy or sell unless you are trading in high volumes.

For greater accuracy in your judgements use the EMA 20/50 signals in conjunction with some of the candlestick patterns we have already covered.

I wont even begin to try and explain the formulas used to calculate the moving averages (both SMA and EMA) as, to be honest, for most small investors, what the moving averages tell us is far more important than how they were calculated. If you do want to take a more in-depth look at how they are created check out the link below:

http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:moving_averages

Next time: The MACD

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself. 
 

Reading the Signs

Celticheart Investor

A beginner's guide to trading and investing

Interpreting candlestick charts might seem complex at first but as with all things, the more you understand the easier it gets. There are many elements that can be applied to charting (Stochastics, Bollinger bands often called BBs, Parabolics, Fibonacci numbers and MACD) but for now we will focus only on the candlesticks themselves and look at the others an element at a time. Trying to understand them all at once would only add to the confusion.

To recognise what the candlesticks mean we have to look at the patterns they form. It is by seeing repeating patterns that we come to understand the likely course that trading will follow. Basically all candlestick charts are mapping is sentiment; whether or not the market is positive, negative or neutral and more importantly which way the trend is going to shift.

To start with there are a only a few basic elements you need to worry about, as I mentioned earlier the basic structure of the bar is as shown here on the left with a main body in solid or white and wicks at top and bottom. These are frequently also shown as red and blue or green.

You don't really need to worry about what they are called only to recognise the shapes and the patterns they will form part of in your candlestick chart. It does help to know their names though so that you understand what others are referring to.

So lets look at some basic indicators and what they mean. Candlesticks come in three basic types; Bullish (buyers are dominant), Bearish (Sellers are dominant) and if they are Neutral (Neither buyers nor sellers are dominant).  

If the pattern is bullish then the likelyhood is the share price will either stay as 

it is or rise, if it is bearish then there is a chance the share price will drop and 

of course if it is neutral the price will not change.

The trick is to try and anticipate the change of direction or sentiment before it happens or at least recognise the start of that change. These are some basic patterns that will help you identify that change. 

Some are stronger signals than others but I would always say not to take one signal alone as a certainty, look for conformation signals to back it up.

Below is an example of such a change in direction from earlier today on MAGP showing a shift in sentiment from bearish to bullish.

The chart on the right was based on 1 hour increments but the same principles can apply on a daily, weekly or monthly basis too. The hammer followed by the long red bar was a sign that this share was being oversold and would probably reverse upwards but it was not until two hours later with the doji formed that it was confirmed.

Before we look at more complex patterns it is probably wise to look at simple reversal signals based on as few as 2 or 3 candlesticks. To start with stick to daily chart comparissons although later on you might want to look more frequently on fast moving shares. These are of course just a selection, there are many others to look for.

Below you will see examples of all three types, Bullish, Bearish and Neutral. Some signals are stronger than others but we will come back to that later on. Don't be too focused on the colour as it is not as important as the size of the main body and its relationship with its neighbours.

I have already referred to this book in a previous blog but for me it is an accessible introduction to understanding the basic fundamentals of analysing candlestick charts.

http://www.amazon.co.uk/Candlestick-Charts-introduction-candlestick-char ts/dp/1905641745/ref=sr_1_1?ie=UTF8&qid=1352029161&sr=8-1 

Next time:  How the Candlesticks are formed

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.