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5 Stock Trading Terms to Know and Understanding

Updated on September 30, 2018
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Chris does online trading during the week, this is one reason he and his family enjoy life and each other. He hopes this helps you.

Making Money Online Trading

Most people want more than what they currently have. This is not a bad things to want, but you do need to be careful on how you try to obtain more. Online trading is one of the ways that people decide to try to earn money. Unfortunately, the many people do not put in the time to learn how to make a strategy or have the patience to stick with a strategy if they do. When a search for "earn money online trading" there are just under 70 million results. An industry has grown around online trading and trying to get some of your money.

We will cover five terms that you will hear in videos that don't get discussed too often in detail. Most of the presenters assume that you will have basic knowledge about trading and will simply say the term. In these five cases the terms we are going to review are types of indicators.

What is an Indicator

An indicator is a way to help investors decide on good buys and when to buy and sell. Five common indicators are:

We are going to review what the term is and how to use these indicators. These are all indicators and are never 100% methods. One thing about the stock market is that nothing is 100%. Many traders are successful because they limit how much a loss can hurt them and take advantage of profits as well as possible.

Click thumbnail to view full-size
All three periods.Variables for the SMA.15 Period100 Period200 Period
All three periods.
All three periods.
Variables for the SMA.
Variables for the SMA.
15 Period
15 Period
100 Period
100 Period
200 Period
200 Period

Simple Moving Average

The Simple Moving Average (SMA) is one the most basic and popular indicators. This takes the average that you indicate and plots this. There are options that you may change and this is one of the reasons that there are three colored lines above. The 15 period is green, the 100 period is yellow, and the 200 period is red.

Period is said because if the chart changes so does the duration. On the images above the period duration would be one day. But if you decide to look at a chart that is 1 day long with plots that are one minute, then the period is in one minute increments. A 15 period would be the average of the last 15 minutes and when a new minute is up, then the oldest minute drops off and the newest is added and than those 15 periods are averaged. Hence, the name moving average because every new period this average is adjusted.

SMA with 15 period:

SMA = (C[1] + C[2] + C[3] + C[4] + C[5] + C[6] + C[7] + C[8] + C[9] + C[10] + C[11] + C[12] + C[13] + C[14] + C[15]) ÷ 15

With the next closing the C[1] would drop out and C[16] would be added, thus creating a moving average.

There are reasons to use different length of periods. The shorter the period the more volatile the average will be because small changes can make an impact easier. Another way to say this would be, a shorter period responds to price changes quicker and has less lag. Generally, a person will compare a shorter period SMA with a longer period SMA and if the shorter period SMA is above the longer period SMA there is generally an upward trend and if the longer period is over the shorter period there is usually a downward trend. This helps indicate a pattern to help investors decide when to buy and sell stocks.

If the SMA is over too long of a period then there is more of a delay in the indicator to buy and sell. You do want some responsiveness in both lines to determine a good pattern that shows the price changing on ups and downs consistently. A rule of thumb is as follows:

  • 5 - 25 period is short-term
  • 25 - 100 period is intermediate
  • 100 - 250 period is long-term

But the pattern is more consistent with 15 period and 100 period above rather than a traditional long-term SMA, and this is what I would recommend in this situation. The 15 period and the 100 period SMA's. An advantage to the SMA is that it is good for finding resistance and support levels because the averages are all given the same importance.

Option Alpha is a youtube channel that offers a good explanation of SMA. A link is included below that is quite helpful and one of the best explanations that I have come across on youtube.

Click thumbnail to view full-size
EMA 15 Green, 100 Yellow, 200 red.EMA options.EMA 15 period.EMA 100 period.EMA 200 period.
EMA 15 Green, 100 Yellow, 200 red.
EMA 15 Green, 100 Yellow, 200 red.
EMA options.
EMA options.
EMA 15 period.
EMA 15 period.
EMA 100 period.
EMA 100 period.
EMA 200 period.
EMA 200 period.

Exponential Moving Average

The exponential moving average (EMA) is a weighted moving average (WMA) that is similar to the SMA but it gives more importance to more recent closing prices. Most EMA's are based off of closing prices for the periods. The shorter the period the more it is weighted by the EMA. The formula for EMA is as follows:

SMA: 15 period sum / 15

Multiplier: (2 / (Time periods + 1) ) = (2 / (15 + 1) ) = 0.125 (12.5%)

EMA: {Close - EMA(previous day)} x multiplier + EMA(previous day).

Knowing the formula for EMA doesn't help many people. A key to EMA is that it is weighted so periods that are closer to the current time frame are more reactive or change quicker. This means that the EMA is a good tool for indicating when there will be changes and will show this faster than the SMA.

Again, Option Alpha provides one of the best descriptions of the EMA on youtube. The link is below to give another explanation of EMA and help you understand the function of this indicator and how to use it. I will continue to provide multiple explanations of the terms discussed.

Relative Strength Index

Relative Strength Index (RSI) is an oscillator that indicates an overbought or undersold state for a stock. Being overbought or undersold implicate a pricing adjustment is going to happen.

RSI = 100 - 100 / (1 + RS)

RS = average gain during period / average loss of period

Overbought is an expression that means the price is over the true value of a stock. For the RSI this is generally set at 70 or 80. 70 is more conservative but some investors want to make sure to get the highest price possible and will use 80 instead to try to get the highest pricing possible. Around these levels is where the price will begin to drop or pullback. This is an indicator of where a resistance will occur as well. In the example above there is a 70/30 RSI and shows a period when the stock was overbought and then a pullback in pricing.

Undersold is a statement that means the value is under the true value of a stock. The two most frequent lower parameter is 30 or 20. This is an indicator of a support line. By using 20 the price is likely to go lower before an investor will buy, and 30 is the more conservative number to use.

There are times that one could view the RSI and the SMA to find sold resistance and support levels for a stock, and then using the EMA one could see if a stock is worth purchasing. The price show an ascending pattern on the EMA, but the RSI shows that it is close to a resistance. This would be an indicator to pass on the stock and wait for the decline and purchase at the support level.

Trading 212 does a great job with explaining stock RSI in a video format that is provided below. If a more in depth explanation is needed, this video should help.

Click thumbnail to view full-size
MACD with 12, 26, 9 sets.MACD Options.
MACD with 12, 26, 9 sets.
MACD with 12, 26, 9 sets.
MACD Options.
MACD Options.

Moving Average Convergent/Divergent

The moving average convergent/divergent (MACD) is an indicator that shows the difference between two EMA lines, how big the difference between the two, and compared to an EMA of the MACD itself. The standards are a 12 period EMA and a 26 period EMA for the MACD compared to an EMA of the MACD results.

The red line in the image above is the signal line, which is an EMA with a period of 9 of the MACD. The white line is 12 period EMA - 26 period EMA. The histogram or vertical red and green blocks are the difference between the signal and the MACD and if a positive or negative comparison.

MACD = 12EMA - 26EMA

The MACD is used to indicate the strength and show buy and sell triggers for a stock. There may be an indication of duration of pricing structures with the MACD. But one should always remember that no indicator is ever 100% accurate.

One of the best video descriptions I have seen for MACD is by David Moadel. David seems to always put a woman on his thumbnails, but disregard this because the video does do a great job explaining MACD if you are in need of another approach to understand.

Click thumbnail to view full-size

Volume Weighted Average Price

The volume weighted average price (VWAP) is an indicator that helps with pricing for a stock. Most VWAP studies will show the VWAP as well as two deviations, one at 2 and another at -2. But the actual VWAP line is the middle of these three. There are softwares that will only give the actual VWAP line, such as the first image above. The first image is from Ally and the second is from thinkorswim by TD Ameritrade. The thinkorswim image is the only image not using OIL for a display and it is showing AMZN.

The VWAP is an indicator to show if you are getting a good price and if the price will be ascending or decreasing. This gives an indication of entry and exit levels within a stock.

If using the VWAP with the 2 and -2 deviant lines these can be put into two indicators of buy and sell with the VWAP being the middle ground. With these lines, the -2 is where the price will often bounce off and is a good entry point while the VWAP is the first resistance. If the price breaks through the VWAP it will can hit the resistance of the 2 deviant line and this would be a good selling point. Again, as with all indicators - none of these are 100%.

Using Indicators

By using multiple indicators it can support decisions on buys and sells. One of the most important factors is due diligence and knowing what your risk management will be, entry point and exit points. There have been buys that I have stopped because although it is in a wedge up, the RSI shows that it will be cresting soon and I hold off on the buy in. Being profitable in the stock market is about choosing good entry points and risk management more than anything else.

Recommended Reading

There are many books available for investing. No matter what type of trading a person wants to do, I would always suggest learning how to do technical analysis and charting. A day trader, swing trader, or investor would all need to be able to look at different types of analysis in order to complete their due diligence. It is that reason, I highly suggest Charting and Technical Analysis by Fred Mcallen. When last viewed, this was a free ebook if a member of Kindle Unlimited.

© 2018 Chris Andrews


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