You do not need more indicators. You need to know more about the ones you are currently using. -Unknown

Though I’m more of a simple price action trader, I find few indicators useful while doing my analysis.

Moving averages and ATR are the two indicators that I use in my analysis.

Today we will discuss in detail how a simple indicator like moving average can help you take better trading decisions, and enhance your edge.

So, Mainly There are two types of moving averages:

• 1) Simple moving average (SMA)
• 2) Exponential moving average (EMA)

The primary difference between both is their sensitivity to the price.

SMA’s are less sensitive to price movements as compared to the EMA’s.

There can be many ways in which you can use moving averages, a few of them are:

• 1. Identifying the trend
• 2. Identifying the extended breakouts
• 3. Selling into strength
• 4. Trailing SL

Let’s deep dive into these.

1. Identifying the trend

We can use moving averages in identifying the trends and the strength of those trends.

Most traders prefer to use 9,20,50,200 MA’s.

20 MA is used for identifying the short-term trend. (1-2 months)

50 MA is used for identifying the medium-term trend. (3-6 months)

200 MA is used for identifying the long term trend (1 year+)

Now, few traders like to use EMA’s and few like to use SMA’s, though there is not as big of a difference.

When the short, medium, and long-term trend comes in tandem and moves in the same direction, we get explosive moves.

As, as you can see, when the trends align, we get explosive moves, and Moving averages are a very easy way to know the short, medium, and long-term trend of a security.

So, if you see a bullish setup in a stock, check whether it is in an uptrend or a downtrend.

Say, you see a bullish setup in a stock, but it is below its 20 DMA, but above 50 and 200 DMA, and you see another setup that is above all of its moving averages, you should give priority to the second one, as it will have ease going up.

And vice versa for the downtrend.

So, when you have identified the short, medium, and long-term trends, now it's time to know about the strength of those trends.

The slope of the MA’s is an easy way to know the strength of the trend, what do I mean by strength.

Take a look at the below chart, Stock is in a strong uptrend thus the moving average slope is also rising, and in the second stock you can see that the stock is in an uptrend but it is not as good as the first one, thus its moving average slope is somewhat flat.

When you train your eyes by looking at different charts with moving averages, you will be able to identify the strength of the trend by looking at the moving average slope.

But, you have to use a consistent number of candles in a chart, otherwise, the moving average slope will change with changing the size of the chart.

Now, traders get into trouble when these MA’s get flat, once the 20 daily SMA crosses below 50 daily SMA after a good uptrend, we can expect the trend to go into the sideways phase, and traders might get into a lot of whipsaws.

Now, once we see the MA’s get flat, the first and second breakouts are most vulnerable to failures.

Basically, the stock will find it hard to get into the trend mode again, so the first few tries to breakout will be very volatile.

Once the stock has spent a good amount of time into the sideways zone, and the volatility reduces significantly, after the first 1 to 2 Fakeouts, it's a high chance that a trending move will come.

At this point keep a closer look at 50 Daily SMA, most of the time the stock will give shakeouts and rejections around that point, and the breakout of that rejection might turn out to be an excellent entry point.

2. Identifying the Extended breakouts

See, Entering a breakout doesn’t mean that you will buy extended stocks, most traders make this mistake and then they say breakout trading doesn’t work.

What do I mean by extended breakouts?

Once the stock has made an impulsive move, and is away more than 20% from the 50 DMA (in the case of an F&O stock), and is giving a breakout at that point.

It might not give a favorable Risk to reward ratio, as there is a high chance of the stock to either go into big consolidation or retrace back to the averages.

Now, I'm not saying that every stock will retrace back to the averages, but most will, and even if they do not, the move on the upside will not be easy to ride.

What I'm trying to convey is try to enter into breakouts when the stock is near to its averages (less than 15% away from 50 DMA in case of F&0 and less than 25-30% in case of Non- F&O scrips).

In this way, you will avoid fake out trades and will be able to identify the right entry points.

A recent example of an Extended breakout was BEL.

The stock was in a good uptrend and made an impulsive move from around 140-185 rs.

After that, we saw a short consolidation period of around 15 days, and it again tried to break out around 190 rs, I remember many of my friends over Twitter who bought it that day.

But, The distance from the 50 DMA was around 13-14% at the time of Breakout, which means that the stock was a bit extended.

Thus, if you enter at this level, your Risk is more than your expected reward.

he stock did not give any follow-through up move and fell right after the breakout to around 160 levels (Around 50 DMA) from 190.

And after that, the stock again resumed its uptrend, but most traders made losses in that trade.

Also, each scrip has different volatility, few stocks get extended after moving 15%, few can stretch the moves up to 40-50%, so you should also check historical volatility levels of each stock to know their extended levels.

Like if you look at the chart of IB real, the stock is very volatile and can move more than 40% in trending up move.

So, if you get a breakout around 15-20% in this stock, that won’t be extended, because it's less than its historical volatility.

I hope that you got the point.

3. Selling into strength

Now, the same concept of extended stocks can be used to sell your holdings if you are a momentum trader.

When the stock goes 20% above the 50 DMA (F&O scrips) it might be a good idea to sell into the strength.

You can make different strategies to sell into strength.

Once you identify that the stock is extended, and if you don’t want to sell into strength but want to use a trailing stop loss mechanism.

Say you were trailing your stop loss at every 2 ATR moves, now as you have identified its extended, you can change your TSL to move with every 1 ATR move.

Or if you are comfortable leaving some money on the table, you can sell at certain percentage point increments above the extended points.

Say 25% qty exit at 20% move away from 50 DMA, 25% qty at 25% move and rest at 30 and 35% move.

IMO every way of selling will come with its pros and cons, and you can choose whatever is more suited to your strategy.

Let's again take the example of IB real about which we talked earlier.

As we talked about earlier, this stock is a bit volatile and trending moves can go up to 40-45% away from 50 DMA.

Again you can see in the above chart that the stock went 50% away from 50 DMA after the breakout from 125 to 170 Rs, giving a good level for traders to sell into the strength.

See, it's not that you will be able to catch the top in a scrip, the intention for selling into strength is not catching the top, there is no way you can catch the top of a stock.

The intention is to keep the equity curve smooth, with TSL methods the equity curve is a bit volatile, though I follow both methods, you can choose whatever is suitable to you.

4. Trailing stop loss

Moving averages can work as dynamic support and resistance, as during trending moves stock may not move towards horizontal support and resistance.

So, you can use a moving average as a trailing mechanism for your system.

Short-term moving averages will be useful for catching small trends and longer-term averages will be useful for catching big trends.

You can use 20, 50 SMA’s as your Trailing stop losses.

For riding short to medium-term trends you can use 20 DMA, you can use the candle close below the moving average as the exit signal.

Similarly, you can use 50 DMA to ride bigger trends.

So, if you are a beginner, this is a very good method of trailing to start out with.

Final thoughts

Simple things work if you know how to use them properly, and moving averages are no different.

Everyone uses them, but very few know how to use them correctly.

My advice to you will be that don’t try to find the best indicator, learn more and deeply about the few which you use.

So, that's it for today from our side, we will meet you next week, till then don’t forget to share this article with your friends over social media.

Thanks for reading