Last updated on May 14th, 2020
My preferred style of trading is swing trading using various options strategies. I consider a swing trade holding a position for a period of 2 days on out to 4 weeks. That is the sweet spot that I have identified when using many types of strategies.
I have found a handful of moving averages to be very helpful for identifying different trade opportunities. Moving averages are very basic in function but can be very powerful since every trader out there uses them.
For me, simplicity is key. The more layers I add into my system, the worse my trading tends to be. This is due to my tendency to over analyze trades.
Using a few moving averages is a great way to identify options trading opportunities.
Trading Indicator Dilemma
Login to any charting platform and you will see dozens of different technical indicators that can be used to help identify trade opportunities. There are endless ways of approaching markets with these different indicators. It can often lead to a never ending pursuit of the perfect trade. In reality there is no perfect trade.
The key is to have a reliable system in place that will put the odds in your favor over time.
Let’s take a look at my favorite moving averages to use in my weekly options trading.
Simple Vs Exponential Moving Averages. Which is best?
A simple moving average is calculated by adding recent prices and then dividing that by the number of time periods in the calculation range. The simple moving average gives equal weight to each data point in the calculation range.
An exponential moving average on the other hand places a greater weight and significance on the most recent data points. It will react quicker to changes in stock price when compared to a simple moving average.
I like to use the simple moving averages when looking for longer term market direction. They can be great ways to confirm your outlook as bullish, bearish, or neutral.
The exponential moving averages are better tools for confirming individual trades. For example, the 8 period EMA is one of my favorite tools to use when looking for changes in direction. These are some of the popular day trading moving averages that are used.
Both the simple and the exponential moving averages can be powerful tools to use. I use a mix of both on a daily basis in my own trading.
Simple Moving Averages. Less Is More.
The key with moving averages (like any technical indicator) is to not get carried away with how many you use.
Support and resistance levels will always be broken at some point. You don’t want to use too many moving averages as it can lead to a paralysis by analysis mode where you are looking at too much information. This can make it hard to pull the trigger on a trade.
I use a handful of simple moving averages on my charts. I prefer to use them on either a 195 minute chart which will give you 2 candles a day or a daily time frame. It does not mean you can’t use them on shorter time frames like an hourly or 15 minute chart. However, using a swing trading approach I prefer to use the longer time frames.
These moving averages can act as great areas of support and resistance. Should these levels break it can lead to big moves in either direction. Using options on these moves can produce impressive returns over a period of a few days on out to a few weeks.
Here are the simple moving averages I like to load up on my charts:
- 20 Simple Moving Average
- 50 Simple Moving Average
- 200 Simple Moving Average
Exponential Moving Averages
Like the simple moving averages, I use a handful of exponential moving averages on my charts.
Here are the exponential moving averages I like to load up on my charts:
- 8 Exponential Moving Average
- 20 Exponential Moving Average
- 50 Exponential Moving Average
- 89 Exponential Moving Average
- 200 Exponential Moving Average
For changes in direction, I like to look for price to break through the 8 EMA. This can lead to powerful reversals off price extremes.
The 8 EMA can also be used as a trailing stop. For example, let’s say price action breaks to the upside and you buy the call options. One way of managing this trade is to hold until the stock price closes below the 8 EMA on the 195 min chart.
These moving averages are looked at for areas of support or resistance. I like to look at where price is at in relation to the moving averages but also the space between the moving averages.
If moving averages are very close to each other, then that can typically lead to a breakout in price coming. Much like a coiled spring getting tighter and tighter.
At some point that spring will pop.
Stocks will act that same way.
Out of a slow stretch it’s very common to see very big moves. That can open up the opportunity for more directional options trades like long calls or puts or debit spreads.
If the moving averages are spread apart that will typically happen after a long trending type move. This can often signal an exhaustion point coming soon and can provide a good opportunity for options credit spreads.
As options traders we have many tools available to us.
Don’t get carried away with using too many indicators when trying to find trades.
Keeping things simple and focusing on price action as much as possible will lead to better returns over the long haul.