Moving averages are primarily used as trend indicators and trend filters. They are quantified technical trading indicators that can be used for backtesting and signal creation. Using moving averages to capture profitable trends are only one side of their usefulness.
What enables moving averages to work as profitable technical trading tools is their ability to manage risk.
Here are five ways to use a moving average as a risk management tool.
- Moving averages can create good risk/reward ratios by establishing the risk in any trade entry by using a moving average as a stop loss.
- After an entry with a longer term moving average if the trade goes in your favor you can use a shorter term moving average as a trailing stop loss to manage the risk of your open profits on a winning trade.
- Moving average signals can keep you in cash during bear markets and downtrends to avoid big losses by fighting a trend.
- The distance your price level entry is from your moving average can help you establish a proper position size for the distance of your stop loss.
- A moving average crossover signal can help filter out the false signals during a volatile market environment and avoid unnecessary losses being chopped up.
Moving averages can both make you money during up trends and help save you from losing a lot of money during volatility and downtrends.
Chart Courtesy of TrendSpider.com