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What You Should Know about Moving Averages and Penny Stocks

Moving averages (MA) are valuable tools for generating clear buy and sell signals for penny stocks. They are simply the representation of the average price of the shares over a time frame that you select. For example, a nine-day MA displays the average price on any given day from the nine days prior to that day.

The MA is displayed as a line across the upper portion of the trading chart, overlaying the stock’s price line. Generally, multiple MA’s are applied at the same time to provide the greatest amount of clarity for your trades.

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MA’s are backward looking, meaning that they’re displaying what prices have done up until this point rather than predicting what the shares will do going forward. However, by spotting shifts in price momentum of a stock, illustrated by MA lines of different time lengths crossing, you can theoretically spot trends when they begin.

The logic behind this TA indicator is that when shares begin to increase or decrease significantly, their new prices will outpace the lagging MA. This outpacing is displayed by the MA breaking away from the price of the shares.

For example, when a major uptrend begins, the share price will start moving higher. This will then be followed by a rise in the shorter MA over the following days, as average price over the MA span begins to increase. Finally the long-term MA will begin to float upward, lagging the short term MA.

Any investor using MAs should consider the following concepts associated with MAs:

  • Various lengths of time: Choosing the duration of the MAs is the most important part of using them successfully, and there is no single correct answer. Instead, finding an effective duration comes down to finding what is most reliable for you.

    The shorter the MA time frame, the more responsive to price moves it will be at first, because fewer days are used to calculate the average. Some common MA time frames include 9- and 27-day MAs, or 8-, 13-, and 21-day MAs, or even 8-, 34-, 55-, 89=, and 144-day MAs.

  • Number of MAs: Most technical analysis involves two MA lines. Some investors use only one MA, while others find that three or more are most useful.

    Generally, two MA lines is the only consistently effective and reliable approach when dealing specifically with penny stocks.

  • Buy signals: Any time a short-term MA crosses above a longer-term MA, it implies a buy. This is because the action of the MA indicators is displaying that the short-term prices are trending up, and, therefore, the stock is in an uptrend.

  • Sell signals: When the shorter-term MA crosses below the longer term MA, it suggests a sell. The action of the MA lines is displaying that prices in the shorter term are moving lower beneath the longer-term average price and, therefore, the stock is in a downtrend.

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