As a trader, you need to master the two technical indicators that are very simple to use but most effective. These are the trendlines and the moving averages. These two technical indicators can be used with a naked eye by just eyeballing the chart. They work for all markets. While calculating the moving averages, the time period used to calculate the average is very important. The shorter the time period, more fluctuations and whipsaw. What this means is the chances of getting wrong trading signals increase with shorted time periods.
Moving averages can be simple, weighted or exponential. In case of simple, all the prices are treated equally whereas in the weighted and the exponential averages, recent prices are given more weight so that these averages are more responsive to the recent prices as compared to the old ones. These averages tend to smooth out the price action that is more easy to interpret and understand.
On the other hand, longer time period averages move slowly with a smoother curve that can be slow in giving trading signals for entering into a long or short position. Now many traders use a combination of slow and fast moving averages in generating trading signals.
Many traders use a combination of three averages like the 4, 9 and 18 period. When the short moving average crosses the medim one this generates a trading signal. Now this trading signal is confirmed when both the short and the medium move above the longer period average. Stock traders tend to move longer periods like the 40 day, 100 day and 200 day averages to determine whether the stock is bullish or bearish.
When using moving average crossovers as a technical indicator, you should be long when the short average is above the longer period average. And when it is below, you should be short.
These crossovers between the three averages are an indication the momentum is shifting from one direction to another. Moving Average Convergence Divergence (MACD) is based on these averages and is a powerful technical indicator in the trading arsenal of any trader.
One important caveat about these averages that you need to always keep in mind is that moving averages are lagging indicators and do not work well in choppy or non trending markets. However, in trend markets, they work very well. You need to master them if you want a winning edge in trading!