How can you use moving averages to inform stop loss levels for swing trading? (2024)

Swing trading is a popular strategy that involves holding positions for a few days to a few weeks, aiming to capture price movements in the market. However, swing trading also involves risk management, and one of the most important aspects of risk management is setting stop loss levels. Stop loss levels are the prices at which you exit a trade if it goes against you, limiting your losses and protecting your capital. One of the data points to consider in setting stop loss levels for swing trading is the moving average. Moving averages are indicators that smooth out the price action and show the average price of an asset over a certain period of time. In this article you will learn how to use moving averages to inform stop loss levels for swing trading. You will also learn about some key drawbacks to setting your stop loss levels by only considering the moving average, as well as some of the upsides of considering this information. (This section has been updated by LinkedIn editors based on member feedback.)

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  Paul Lange

  Founder at Disciplined Trading Strategies, LLC

  20

Moving averages are calculated by taking the sum of the closing prices of an asset over a certain number of periods, and dividing it by that number. For example, a 10-day simple moving average (SMA) is the average of the closing prices of the last 10 days. There are different types of moving averages, such as exponential moving averages (EMA), which give more weight to recent prices, or weighted moving averages (WMA), which assign different weights to different prices. Moving averages can be used to identify trends, support and resistance levels, and signals for entry and exit.

The simplest way to use moving averages as stop loss levels for swing trading is to place your stop loss below or above the moving average, depending on whether you are long or short. For example, if you are long on a stock that is trading above its 50-day SMA, you can place your stop loss below the 50-day SMA, which acts as a support level. If the price breaks below the 50-day SMA, it indicates that the trend may have reversed, and you should exit your trade. Similarly, if you are short on a stock that is trading below its 50-day SMA, you can place your stop loss above the 50-day SMA, which acts as a resistance level. If the price breaks above the 50-day SMA, it indicates that the trend may have resumed, and you should exit your trade. However, before you set a stop loss level solely on a moving average, you should consider the disadvantages of using this approach, and how additional considerations might influence your choice of a stop loss level. (This section has been updated by LinkedIn editors based on member feedback.)

Using moving averages as stop loss levels has some advantages, such as its simplicity and ease of implementation. You don't need to calculate complex formulas or use multiple indicators; you just need to follow the moving average and adjust your stop loss accordingly. Additionally, it is adaptive and dynamic, reflecting the current market conditions and helping you avoid getting stopped out too early or too late. Lastly, it is objective and consistent, providing a clear and reliable reference point to exit your trade that isn't affected by your emotions or biases.

Using moving averages as stop loss levels also has some disadvantages. For instance, it is lagging and reactive, as it is based on past prices and may not catch up with the current price quickly enough, resulting in larger losses or missed opportunities. Moreover, it is not precise or optimal, as it can be breached or crossed multiple times, causing false signals or whipsaws; and it can be too far or too close to the price, resulting in too much risk or too little reward. Lastly, it is not universal or flexible, as it may not work well for every asset, time frame, or market condition and may require fine-tuning or customization to fit your trading style and objectives.

When considering what is the best moving average for stop loss levels, there is no definitive answer as it depends on various factors. The length of the moving average can affect how it reflects the long-term trend or short-term fluctuations. Generally, longer moving averages are more suitable for longer-term swing trading, and shorter moving averages are more suitable for shorter-term swing trading. Additionally, the type of the moving average affects how it reacts to price changes. EMAs are more sensitive and responsive than SMAs, and WMAs are more sensitive and responsive than EMAs. However, more sensitivity and responsiveness also mean more noise and volatility. The market condition and trend strength also affects how reliable and effective the moving average is as a stop loss level. Moving averages work better in trending and smooth markets, where they can act as support and resistance levels. Conversely, in choppy and sideways markets, they can generate multiple crossovers and signals.

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