Book SummaryMoving Averages 101, by Steve Burns and Holly Burns

1-Page Summary1-Page Book Summary of Moving Averages 101

Understanding Moving Averages

Price Averages Reflect Trends Over Specific Time Frames

In their book, Moving Averages 101, the authors explain that moving averages (MAs) are a fundamental tool in technical analysis. They argue that MAs offer invaluable insights into market patterns and potential trading opportunities. Essentially, a moving average represents the mean price of a security over a specified period, smoothing out price fluctuations and highlighting the underlying trend.

Instead of getting bogged down by daily price jumps and dips, MAs help you see the larger picture. For instance, a 50-day average shows the mean price for the previous 50 market days. This helps filter out the distractions of short-term volatility, allowing you to focus on the dominant price direction. As the price of the security moves, the MA trails behind it, painting a clearer picture of whether the price is generally increasing or decreasing over time.

Types of Averages: Simple (SMA), Exponential (EMA), Weighted (WMA)

The authors delve further into various moving average models, each with its own calculation method and characteristics:

• Simple Moving Average (SMA): This straightforward MA gives equal weight to all prices within the chosen time frame. For example, an SMA over a ten-day period sums the closing prices of the last ten days and divides the total by ten. While simple, it can lag behind significant price changes.

• Exponential Moving Average (EMA): Burns and Burns emphasize that EMAs place more emphasis on the latest prices, which makes them more responsive to current market activity. This makes EMAs particularly helpful for spotting trend reversals earlier than SMAs. A 10-day EMA responds more quickly to a sudden price surge compared to a 10-day SMA.

• Weighted Moving Average (WMA): Similar to EMAs, WMAs also prioritize the latest prices. However, WMAs assign a progressively decreasing weight to older prices within the calculated period. While slightly more complex, this weighting system can make WMAs even more sensitive to changes in current prices compared to SMAs and EMAs.

Importantly, Burns and Burns recommend that traders not get hung up on choosing the 'perfect' type of MA. They emphasize that the true key to success lies in consistently applying a well-defined trading strategy that aligns with your chosen moving average type, regardless of whether it's an SMA, EMA, or WMA.

Practical Tips

• Apply the SMA concept to your fitness routine to measure progress. Record daily metrics such as steps taken, calories burned, or minutes exercised. Calculate the SMA for these metrics over a week or month to get a smoothed view of your activity levels. This can help you set realistic fitness goals and maintain a consistent exercise regimen by highlighting your average performance over time.
• Set up price alerts at key SMA levels to act promptly on significant price changes. If you're using a trading platform, configure alerts to notify you when the price approaches or crosses the SMA you're monitoring. This way, you can make informed decisions based on real-time price movements rather than waiting for the SMA to catch up.
• Optimize your fitness routine by focusing more on your latest workouts to inform future sessions. Keep a workout log and review your performance, noting any increases in weights, reps, or overall intensity. Give more emphasis to the data from your most recent workouts when planning your next week's routine. If you notice you've been able to lift heavier or run faster lately, consider adjusting your goals and workout plan to challenge yourself based on these latest achievements.
• Create a simple spreadsheet to compare EMA responses to market movements with other indicators. Input daily or weekly prices of a chosen stock or commodity and apply EMA formulas available online to calculate their values. Then, choose another common indicator like Simple Moving Averages (SMAs) and do the same. Over time, you'll be able to visually compare how EMAs and SMAs behave in relation to actual market events, enhancing your understanding of...

Moving Averages 101 Summary Using Specific Moving Averages

5-Day EMA: Momentum Indicator for Trading Short-Term Trends and Trailing Stops

Burns and Burns describe the 5-day Exponential Moving Average as a highly responsive indicator, best suited for traders seeking to capitalize on short-term momentum moves. Its sensitivity to the latest price changes makes it ideal for identifying shifts in momentum early on.

The authors suggest several ways to utilize the 5-day Exponential Moving Average:

• Short-Term Trend Confirmation: The 5-day EMA may verify a nascent trend. When the price decisively surpasses and ends above the 5-day exponential moving average, it can signal the beginning of a short-term uptrend. Conversely, a dip beneath could signal a brief decline.

• Trailing Stop Loss: Burns and Burns recommend using a 5-day EMA to protect profits when trades are profitable by serving as a trailing stop loss level. As the price advances and the five-day Exponential Moving Average trails behind, you can tighten the stop-loss level accordingly, securing gains as the trend progresses.

5-Day Exponential Mean Excels in Trends; Generates False Signals in Range-Bound or Volatile Markets

Burns and Burns caution that the 5-day EMA...

Moving Averages 101 Summary Developing Trading Systems With Moving Averages

Spot Patterns With Moving Average Crossovers

Burns and Burns introduce crossovers of averages of price movement as a powerful approach to trend trading, removing subjectivity and allowing traders to base decisions on quantifiable signals. These systems typically involve two moving averages of different lengths (e.g., a 10-day EMA and a 30-day EMA), generating buy and sell signals based on their crossovers.

The authors explain the basic concept of a cross method:

1. Buy Signal: A buy signal is triggered when the faster moving average (e.g., 10-day EMA) crosses above the slower moving average (e.g., 30-day EMA). This suggests that the shorter-term momentum is shifting in favor of the bulls, potentially marking the beginning of an upward trend.

2. Sell triggers: A sell signal is generated when the faster MA crosses below the slower MA, indicating that short-term energy is waning and a downtrend might be underway.

Crossover Systems Outperform Single Moving Averages by Offering Trend Confirmation and Reducing Misleading Signals

Burns and Burns argue that crossover systems based on moving averages offer several advantages over using a lone moving average.

• Trend...

Shortform Exercise: Exploring the Impact of Moving Averages on Market Trends

Consider how moving averages (MAs) reflect market trends over time and the various ways they are utilized in trading strategies.

How might a trader use the 50-day simple moving average to identify potential buy and sell signals? Consider both uptrends and downtrends.