Basic Technical Analysis From The Butcher, page-7

Todays lesson is moving averages. I probably should have spoken about these before bollinger bands, but hey, sucks to be you.

Moving averages coming all sorts of flavours. We're only going to focus on vanilla and chocolate here because unless you get really deep into chart trading you wont need any other, and honestly, I only use vanilla, after all you can always put sprinkles on top.

So the standard moving average and the exponential moving average. The standard moving average is simplify the sum of all the previous close prices summed up, averaged and put onto a point for that period. The exponential ones use an equation which makes it hug the price action a little closer.

Two understand why we have two main types we have to understand why they would even be in our standard toolkit in the first place. Traders tend to use them as buy/sell signals, trading channels momentum indicators and more. Now it depends on your set up and how you use all your charting signals as to whether you use exponential or standard averages, but if you are using them for buy/sell signals standard averages move "slower" than the exponential ones. Hence the reason why someone would chose to use one type over the other.

Now have a look at this chart of some RIO trading action


The blue line is an exponential 20MA and the red is a standard 20MA. Notice that the blue not only front runs the price but it shows the shape of the action better than the standard moving average. Now those advantages are like a doubled edge sword because while its busy showing the price movements better its also being very volatile. The standard moving average keeps us closer to "reality" rather than getting excited like the exponential average tends to.

I'm not going to make a recommendation as to which you chose to use in your set up because they both have clear advantages and disadvantages over one another. personally, I only use standard moving averages because they are tied better to reality like I said but that doesn't mean you should you them too. Just keep in mind they could work better for your set up and the way you trade compared to the other ones.

Now moving averages are normally used in sets. its a good idea to play around with different sets to see which ones work better for you. I used to use 5 but these days I just use 3 because the more indicators you have on a chart the more cluttered it gets and you suffer from information overload. plus as your skills improve you'll find you need less and less signals and tools and you can just look at a chart and make half your decision on it without a single line being drawn. The reason that people use different averages on charts is because they can be used a short, medium and long term momentum indicators especially when they are overlain with one another.