As a day trader, one of the most important aspects of your trading day is to identify ideal trade setups and quickly execute your trades to book a profit on extremely quick moves. This means that the traditional 20-day and 50-day moving average crossovers used by swing and position traders are not suitable for day trading strategies. Therefore, day traders are best served with moving averages that cover fewer periods, such as five or eight, that should be applied on charts covering shorter timeframes – preferably minutes.
Which moving averages work for day traders?
Most day traders use the one-minute, five-minute, 15-minute, and 30-minute charts to find potential trade setups when their objective is to close their positions within a few minutes, or a few hours if they want to hold their trades for longer.
Most moving averages work well regardless of the timeframe to which they have been applied. Whether they are incorporated into a one-minute chart or a one-hour chart, the results are typically the same
Therefore, the most crucial aspect of the moving averages used by day traders is the number of periods covered, with the main goal being to use MAs that cover anywhere from five to 15 periods. This makes it easier to identify trend changes very early.
The best combination of MAs for day trading stocks
Most experts recommend that day traders combine the five-period, eight-period, and 13-period simple moving averages (SMAs) to pinpoint the best day trading opportunities in the stock markets.
The fact that this combination of SMAs is used by many day traders has turned them into a self-fulfilling strategy; they are very effective because most traders execute their trades based on them.
The five, three and eight-period SMAs are connected to the trusted Fibonacci indicator. These three are designed to coincide with the major Fibonacci retracement levels, allowing them to benefit from the significant accuracy associated with the Fibonacci indicator.
Keep in mind that the Fibonacci numbers are derived from sequences that occur in nature, which is why the indicator is so powerful. After all, the price movements experienced in the financial markets are usually triggered by human nature (emotions).
Chart 1: 15-minute GOOGL chart with 5, 8, and 13 SMAs
How to apply the three SMAs to your stock trading activities
Using the chart below, you could have pinpointed several high-probability trade setups triggered when the five-period and eight-period SMAs cross over each other during a period of several days as it is a 15-minute chart.
Chart 2: 15-minute GOOGL chart with highlighted trade setups
Point 1: This is a perfect location for a short trade that you could have held into the next trading day.
Point 2: This was a false buy signal that could have led you to close your short trade from the previous day. Another short signal was generated a few hours later, which could have got you back into the short trade.
Point 3: A bullish trade signal was generated at this point, which could have seen you close the short trade that you had held for the past three trading sessions and enter into a long trade.
Point 4: A bearish trade signal was generated, at which point you would have closed your long trade and stayed out of the markets.
Point 5: A bullish trade signal was generated at this stage, which may have resulted in a long trade that could have been closed at Point 6.
Point 6: This shows a region where the three SMAs were squeezed together, which usually indicates that price momentum is slowing down and that the trend is likely to reverse. This provides an ideal trade exit or entry position once the faster SMAs cross over each other.
The 13-period SMA is mainly used to identify the price trend. The price is said to be in an uptrend whenever it is above this SMA line, and it is considered to be in a downtrend if it is above the SMA.
A word of caution
Keep in mind that there are no perfect indicators. The SMA crossovers could generate false signals and may not work well in range-bound (sideways trending) markets.
The main pivot points are the Woodie, Camarilla, Fibonacci and Demark pivot points, although many other types also exist. Each of these pivot points is calculated slightly differently from the standard pivot point, but they are used in much the same way.
Standard pivot points
These are the most popular type of pivot points and are typically used by traders to determine potential support and resistance levels that can be used as possible trade entry and exit points.
They were initially developed by floor traders operating in the futures markets, where they were mainly used for intra-day trades.
A defining characteristic of pivot points is that they are considered a leading indicator, which means that they can predict future price movements. In contrast, popular indicators such as moving averages are lagging indicators.
Pivot points are also used by traders to measure an asset’s trading bias, whether it’s bullish or bearish, over a given time period.
They are quite popular in the Forex markets, where FX traders use them to identify potential breakout and reversal trading opportunities during periods where there is significant trading volume.
However, some experts have criticised the actual effectiveness of pivot points, terming them a self-fulfilling prophesy and downplaying their intrinsic value as a leading indicator.
Chart 1: Gold 4-hour chart with standard pivot points
Calculating standard pivot points
The first step in calculating standard pivot points is to find the baseline pivot point (P).
Pivot Point (P) = (High + Low + Close) / 3
The baseline pivot point acts as the centre pivot from which the other four pivot points are calculated.
The first support level (S1) is calculated by multiplying P by 2 and then subtracting yesterday’s high.
S1 = (pivot value * 2) – yesterday’s high
The first resistance is calculated in a similar manner, but instead of subtracting yesterday’s high, you must subtract yesterday’s low.
R1 = (pivot value * 2) – yesterday’s low
Next, calculate the second support level (S2) and the second resistance level (R2)
S2 = Pivot Value – (High – Low)
The second support level is calculated by subtracting the different between the high and low from the baseline pivot value.
R2 = Pivot Value + (High – Low)
The second resistance level is calculated by adding the difference between the high and low to the pivot value (P).
Chart 2: Gold 4-hour chart with historical standard pivot points
Woodie pivot points
The Woodie pivot point’s main difference from the standard pivot point is that it gives more weight to the previous period’s closing price. The Woodie pivot point is calculated as follows:
R2 = PP + (High – Low)
R1 = (2 X PP) – Low
PP = (High + Low) + (2 x Closing Price) / 4
S1 = (2 X PP) – High
S2 = PP – (High + Low)
Camarilla pivot point
Camarilla pivot points are quite similar to Woodie pivot points in the sense that they give more weight to the previous closing price. However, they are different because they require four support levels as well as four resistance levels.
They are calculated as follows:
R4 = Closing + ((High -Low) x 1.5000)
R3 = Closing + ((High -Low) x 1.2500)
R2 = Closing + ((High -Low) x 1.1666)
R1 = Closing + ((High -Low x 1.0833)
PP = (High + Low + Closing) / 3
S1 = Closing – ((High -Low) x 1.0833)
S2 = Closing – ((High -Low) x 1.1666)
S3 = Closing – ((High -Low) x 1.2500)
S4 = Closing – ((High-Low) x 1.5000)
Fibonacci pivot points
These are pivot points that incorporate additional Fibonacci levels onto the standard pivot point calculations. They are determined as follows:
Resistance 1 = Pivot + (.382 * (High – Low))
Resistance 2 = Pivot + (.618 * (High – Low))
Resistance 3 = Pivot + (1 * (High – Low))
Pivot Point = (High + Low + Close) / 3
Support 3 = Pivot – (1 * (High – Low))
Support 2 = Pivot – (.618 * (High – Low))
Support 1 = Pivot – (.382 * (High – Low))
Demark pivot points
Demark pivot points were invented by Tom Demark and are calculated based on the following conditions:
If Close > Open, then X = (2 x High) + Low + Close
If Close < Open, then X = High + (2 x Low) + Close
If Close = Open, then X = High + Low + (2 x Close)
Pivot Point = X/4
Resistance 1 = X/2 – Low
Support 1 = X/2 – High
The bottom line
Most traders use standard pivot points because of their effectiveness, and this becomes a self-fulfilling cycle given their popularity. Standard pivot points also come pre-packaged in most charting software, unlike many other types of pivot points. Therefore, most traders are best served using standard pivot points.