Trading can sometimes feel like navigating a maze, especially with the constant flow of price movements in the market. For traders involved in Share CFDs (Contracts for Difference), finding reliable tools to guide decisions is essential. Moving averages are one of those tools—simple yet powerful, they help smooth out market noise and highlight trends that might otherwise be overlooked. If you’ve ever wondered how to incorporate moving averages into your trading strategy, especially in the UK market, this guide will take you through the essentials.
What Are Moving Averages?
A moving average (MA) is a technical indicator that calculates the average price of a share over a specific time period. It “moves” because it recalculates the average with each new data point, creating a continuous line on the price chart. This makes it easier to identify trends, reversals, and key levels of support and resistance.
For Share CFDs, moving averages are particularly useful because they simplify decision-making. Instead of reacting to every minor price fluctuation, traders can focus on the bigger picture.
Types of Moving Averages
1. Simple Moving Average (SMA)
The SMA calculates the arithmetic mean of prices over a set period. For instance, a 20-day SMA averages the closing prices of the past 20 days. SMAs are straightforward and provide a clear view of the overall trend.
2. Exponential Moving Average (EMA)
The EMA gives more weight to recent prices, making it more responsive to current market activity. This is ideal for Share CFD traders who want quicker signals for short-term trades.
Both SMAs and EMAs have their merits, and the choice depends on your trading style and time horizon.
How to Use Moving Averages in Share CFD Trading
Identifying Trends
Moving averages are excellent for determining the direction of a trend. When the price of a Share CFD is consistently above its moving average, it indicates an uptrend. Conversely, if the price remains below the moving average, the market is likely in a downtrend.
For example, a 50-day SMA can serve as a benchmark for medium-term trends. If the share price of a major UK company like Tesco remains above this moving average, it suggests bullish momentum.
Spotting Crossovers
Crossovers occur when two moving averages of different periods intersect. These are powerful signals for Share CFD trading:
- Golden Cross: When a short-term moving average (e.g., 20-day) crosses above a long-term moving average (e.g., 50-day), it signals a potential uptrend.
- Death Cross: When a short-term moving average crosses below a long-term moving average, it suggests a downtrend.
For instance, if the 20-day EMA of a UK financial stock crosses above its 50-day EMA, a trader might consider opening a long position in its CFD.
Real-World Example
Let’s say you’re trading a Share CFD on BP, a major player in the UK energy sector. The share price has been fluctuating but recently broke above its 50-day SMA, indicating a potential trend reversal. You decide to wait for confirmation and notice a golden cross, where the 20-day EMA crosses above the 50-day SMA. Based on this signal, you enter a long position, placing a stop-loss just below the 50-day SMA as a precaution.
Over the next few days, the price continues to rise, using the 20-day EMA as dynamic support. You adjust your stop-loss upward to lock in profits, eventually exiting the trade when the price shows signs of stalling.
Using moving averages in Share CFDs is a versatile and reliable strategy for identifying trends, spotting reversals, and timing your trades. Whether you’re a day trader looking for short-term signals or a swing trader aiming to capture broader trends, moving averages can provide the clarity needed to navigate the UK stock market confidently.