Moving Averages and Indicators
What this domain tests
This section tests calculation logic and interpretation of trend-following indicators: simple and exponential moving averages, crossovers, MACD, Bollinger Bands, ADX and ATR. You need to know what each indicator measures and what it cannot measure.
Core rules
- SMA = average of the last n closes; EMA weights recent closes more, so it turns faster and whipsaws more in ranges.
- Price above a rising MA suggests an uptrend; MA slope matters more than a single close. Common periods: 20 (short), 50 (intermediate), 200 (long-term).
- Golden cross: shorter MA crosses above longer MA; death cross: opposite. Both lag and should be confirmed by price structure and volume.
- MACD = 12-period EMA minus 26-period EMA; signal line = 9-period EMA of MACD; histogram = MACD minus signal. Crossovers and zero-line crosses are trend signals; divergence is a warning.
- Bollinger Bands = 20-period SMA plus or minus 2 standard deviations. Bands measure volatility, not direction; a squeeze precedes expansion but does not predict direction.
- ADX measures trend strength, not direction; above 25 suggests a trending market. ATR measures average true range and is used for stops and position sizing.
Worked example
A stock closes at 100, 102, 104, 103, 105. The 5-day SMA is (100+102+104+103+105)/5 = 102.8. Price is above the SMA and the SMA is rising, so the trend filter is positive. If the 20-day SMA is 99, a 20/50 golden cross later would add confirmation, but a trader still needs a stop because the MA can flatten.
Traps
- Using a crossover as a standalone buy signal in a sideways market.
- Assuming an EMA is always better than an SMA; it is faster, not more accurate.
- Reading Bollinger band touches as automatic overbought or oversold.
- Forgetting that ADX says nothing about direction.