Charts 101: Cut Risk by Following the Moving Average

Investors looking to get ahead of the curve instead of catching the tail-end of trends should use the technical analysts’ tool of moving averages, Sandy Jadeja, chief market strategist at ODL Securities, told CNBC.

The moving average gives an average price of a stock or market over a set period and can give investors a guide on whether to buy, short or keep clear, according to Jadeja.

In a bear market, like the one stocks are undergoing now, a close below the moving average would signal a move lower, he said.

“You would exit the position only when the market closes above the moving average.”

A close above the average wouldn’t necessarily mean a buy signal, however, as the overall trend is lower and therefore only sell signals would be initiated, Jadeja said.

Watch the full interview with Sandy Jadeja above.

But in a bull trend, “when the market closes above the moving average line, you would go long only. When it closes below the moving average line, you would close the position and wait for another buy signal.” Jadeja said.

“On the FTSE, back in August we had that occur and the market fell all the way down to the October low -- that was quite a move, that was a 25 percent move,” he added.

Investors should also decide on their time scale for investment to decide on what type of moving averages to watch, Jadeja said.

Short-term traders will look at a five-day moving average, but should expect to get quite a few signals, as the short term is more volatile.

An intermediate-term trader should to be looking at a 20-day or even 40-day moving average and longer-term position holders should look at 100-day or 200-day averages.

Following moving average signals doesn’t work all the time so investors should manage their risk by only investing a small portion of their capital at a time, he said.

For the Investor:

Market Tips: Defensive Plays are Passé, Expensive
Pros Say: Euro-Dollar at $1.20; Gold at $1,000