A big thing that trips up new traders is they get an entry signal at a breakout or a bounce off a key moving average like the 50 day simple moving average but have trouble quantifying how to let the it run if it is a winner or cut the loser short if it goes down. How to get out near the top instead of giving back a bulk of the run on the way back down. Shorter term moving averages let you trade a big up trend on a shorter time frame and give you a way to quantify a trailing stop and where to enter and exit if you missed a past key entry point.
I came across this quote from Market Wizard Marty Schwartz from his book: Pit Bull.
“The 10 day exponential moving average (EMA) is my favorite indicator to determine the major trend. I call this “red light, green light” because it is imperative in trading to remain on the correct side of a moving average to give yourself the best probability of success. When you are trading above the 10 day, you have the green light, the market is in positive mode and you should be thinking buy. Conversely, trading below the average is a red light. The market is in a negative mode and you should be thinking sell.” – Marty Schwartz
I agree completely with his observation and I have found the same thing in my independant chart studies. Also in sharply up trending stocks the 5 day EMA is respected and acts as support. At times the 5 day ema also acts as resistance as it currently is in $GOOG as it is having trouble breaking through and holding above the 5 day EMA after falling from all time highs rather quickly. The key is to find an up trending stock that respects the 5 day or the 10 day moving averages and then the moving average itself can be used for entry and exit signals for short term trend identification. I do primarily use the 5 day ema nd the 10 day sma in my own personal trading.
What moving averages do is identify and track trends, they quantify entry and exit points and are not open to opinion: they are facts. They track the real flow of capital and are used as signals by many traders, that is why you will see reactions many times at key levels.
This is a simple system that can get new traders trading on the right side of the market with advice from the pen of a real millionaire market wizard.
