I just published an article over on the Trading Buddy site for my friend, Paul Bratby.  It's on how to use moving averages to determine price trends, entries and exits.  

You'll find the original here: http://www.mytradingbuddy.com/blog/forex/moving-av...

For many years I traded stocks based exclusively on the technical analysis of price charts. As I claimed in my first book, Trend Trading for a Living, it didn’t matter to me whether the company made widgets or shmidgets, I bought and sold shares based on the chart and the chart alone. In fact, in many cases I knew nothing about the company other than its ticker symbol.

I’ve since educated myself in the finer points of fundamental analysis, and for good reason. Familiarity with a company’s growth and valuation metrics can go a long way toward selecting out the best price charts from all the rest. More importantly, strong fundamentals more often than not trump short-term technical weakness, keeping you in the trade long enough to reap the rewards of the stock’ eventual turnaround. As Warran Buffett is fond of saying, “It’s not the buying and selling that makes money. It’s the waiting!”

Still, technical analysis should play a part in any robust trading system. And one of the most widely used of the technical indicators, one you’ll find on almost every price chart, is the moving average. A moving average, as the name implies, is a running average of the closing price of a stock over x number of time periods (normally x number of days or weeks), with each new closing price replacing the first price in the sequence. The most commonly used moving averages are the 50-day moving average, which shows the average stock price over the past 10 weeks, and the 200-day moving average, which does the same for the past 40 weeks. Shorter term moving averages are used to determine the state of the short-term trend. Longer term averages are used to determine the long-term trend. These two averages, the 50-day and 200-day, are so widely used that even the staunchest company analyst, who otherwise would never think to consult a stock price chart, will always know where the stock price stands in relation to one or both of these two key indicators.

There are a number of key benefits to using moving averages on a price chart. We won’t be able to go over all them in this article. Here let me explain that the most important use of moving averages is that they smooth out the “noise” of the day to day ups and downs of price movement. Moving averages render more clearly the upward, downward, or flat directional flow of a stock’s price over time. Even the choppiest of price charts, with a 50-day or 200-day moving average overlaid, will show clearly defined movement. In this way, a quick glance at the moving average of price is all you need to tell whether the stock’s share price is in an uptrend or downtrend, or whether it has, despite the noise, flat-lined.

The S&P 500 with the 50-day Moving Average

In the chart above you will see 8 months of rather choppy price action for the S&P500 with the 50-day moving average overlaid. Through the end of July, there is a clearly defined uptrend. We see price most above the average which itself is steadily rising: these are the classic signs of a strong uptrend. The months of August through October are characterized by the give and take of price volatility. There we see the average has gone flat with the index trading both above and below the line. Finally, the month of November into early December shows a period of lowered volatility as price moves gently upward. Here we see the average turning up with the index well above the line.

Without the moving average, a lot of choppiness dominates the above chart. Any of the price dips in April, May, July, August, and October, might have had you running for the exit, or at least losing some sleep if you were fully invested. With the moving average on the chart, however, only the October dip (an extreme move, to be sure) would have been cause for concern. The rest is merely “noise.”

In addition to determining the health of the current price trend, there is a second way moving averages are used in stock analysis. It is a method made famous by William O’Neil, founder of Investor’s Business Daily and author of the perennial bestseller, How to Make Money In Stocks. While O’Neil is not the inventor of moving averages – that honor goes to a guy who invented them back in 1909 – he was the one who made this particular use of them popular.

Since O’Neil never named this strategy, we’ll call it the “price crossover.” The price crossover is used by those who are trying to pinpoint an ideal entry into a stock they want to buy. It is also used to determine the best time to exit a stock after one has bought it.

The way this strategy is straightforward. You buy the stock on any new close above a flat to rising moving average (like the examples we saw last week), and you sell the stock on a new close below a flat to falling moving average. The most commonly used averages for this strategy are:

• 10day moving average for short-term trades
• 50day moving average for medium-term trades
• 100day or 200day moving average for long-term trades

In the chart below, you will see a set of buy and sell signals on the S&P 500 over about 20 months using the price crossover strategy on the 50day moving average. As you can see, some of the sell signals were a bit premature on this particular chart. But the buy signals do get us in prior to major moves upward. And eventually this chart will show a sell signal that would prevent us from severe loss.

The S&P 500 with 50-day Moving Average Buy and Sell Signals

So there you have it: two ways you can use the most common moving averages to gain a better understanding – apart from the day to day noise of the market’s volatility – of the stocks you trade or invest in. In my next article, I’ll show you two, slightly more sophisticated ways you can use moving averages to time your trading and investing entries and exits.