Moving averages are trend-following indicators that smooth out price action by creating a constantly updated average price over a specific period, appearing as lines directly on the price chart as upper indicators. These versatile tools serve multiple purposes – identifying trend direction, providing dynamic support and resistance levels, and generating trading signals through crossovers. For option traders, moving averages are indispensable for determining market bias (bullish above, bearish below), timing entries when price pulls back to averages, and selecting appropriate strikes beyond these key levels. Understanding the different types and applications of moving averages forms the foundation of technical analysis for successful option selling.
Types of Moving Averages
The two main varieties and their characteristics:
Simple Moving Average (SMA)
- Equal weight to all periods
- True mathematical average
- Slower to react to price changes
- Less prone to whipsaws
- Better for major trend identification
Calculation: Sum of closing prices / Number of periods
Exponential Moving Average (EMA)
- More weight to recent prices
- Faster reaction to price changes
- More responsive to new information
- More trading signals
- Better for short-term trading
Key Difference: EMAs turn faster at trend changes.
Common Moving Average Periods
Standard periods and their uses:
Short-Term Averages
8/10 EMA: Ultra-short trends
- Scalping entries
- Very sensitive
- Many false signals
20/21 EMA/SMA: Monthly trend
- Most popular short-term
- Good for entries
- Balance of signals
Intermediate Averages
50 SMA: Quarterly trend
- Institutional favorite
- Major support/resistance
- Trend confirmation
Long-Term Averages
200 SMA: Yearly trend
- Ultimate trend definer
- Bull/bear market line
- Major psychological level
Moving Averages as Support/Resistance
Dynamic levels that adapt to price:
Trend Support
In uptrends, MAs act as support:
- Price pulls back to MA
- Bounces higher
- Perfect put selling opportunity
- Place strikes below MA
Trend Resistance
In downtrends, MAs act as resistance:
- Price rallies to MA
- Fails and turns down
- Perfect call selling opportunity
- Place strikes above MA
The stronger the trend, the more reliable the MA.
MA Trading Signals
Key signals from these upper indicators:
Price vs MA Position
Bullish: Price > MA
Bearish: Price < MA
Golden Cross and Death Cross
Golden Cross (Major Bullish):
Death Cross (Major Bearish):
- 50 MA crosses below 200 MA
- Long-term trend turns down
- Multi-month bear market
- Aggressive call selling
Multiple Moving Average Systems
Using multiple MAs together:
Triple MA System
20, 50, 200 Configuration:
- All aligned up = Strong uptrend
- All aligned down = Strong downtrend
- Mixed = Consolidation/transition
- Trade with alignment
MA Ribbon
Multiple EMAs (5, 8, 13, 20, etc.):
- Expansion shows trend strength
- Compression warns of reversal
- Visual trend representation
- Entry/exit guidance
MA Envelope/Bands
Percentage bands around MA:
- 2-3% bands common
- Overbought at upper band
- Oversold at lower band
- Mean reversion trades
Moving Averages for Options
Specific applications for option traders:
Strike Selection
Put Selling:
- Identify support MA
- Sell strikes below MA
- Extra protection buffer
- Higher probability
Call Selling:
- Identify resistance MA
- Sell strikes above MA
- Technical barrier
- Time decay advantage
Entry Timing
MA Touch Entry:
- Wait for price to touch MA
- Confirm bounce/rejection
- Enter option position
- Stop if MA breaks
MA Reclaim Entry:
- Price breaks below MA
- Quickly reclaims above
- False breakdown
- Sell puts aggressively
MA Strategies for Different Timeframes
Matching MAs to option duration:
Weekly Options
- 8 or 10 EMA hourly chart
- 20 EMA daily chart
- Quick signals needed
- Tight stops required
Monthly Options
- 20 and 50 SMA daily
- More reliable signals
- Wider stops acceptable
- Less management
LEAPS
- 50 and 200 SMA weekly
- Major trend focus
- Rare adjustments
- Position trades
Advanced MA Techniques
Sophisticated applications:
Dynamic Position Sizing
- Far from MA = Normal size
- Near MA = Reduce size
- At MA = Minimum size
- Past MA = No position
MA Slope Analysis
- Steep up = Strong trend, sell puts
- Flat = No trend, iron condors
- Steep down = Strong trend, sell calls
- Slope change = Trend weakening
Volume at MA
- High volume MA test = Significant
- Low volume MA test = Suspect
- Confirms importance
- Guides position size
Common MA Mistakes
Too Many MAs: Clutters chart Wrong MA Type: SMA for scalping Ignoring Slope: Flat MA = no trend Fixed Settings: Adjust to market
Building an MA System
Systematic approach:
Daily Routine
- Check price vs key MAs
- Note MA slopes
- Identify MA tests
- Plan entries at MAs
- Set strikes beyond MAs
MA Trend Following
Rules:
- Price > 20 MA > 50 MA = Only puts
- Price < 20 MA < 50 MA = Only calls
- MAs mixed = Stay out
- Exit if structure breaks
Performance Tracking
- Win rate by MA setup
- Best MA for entries
- Optimal distance from MA
- MA break statistics
MA Special Situations
Unique applications:
Gap and MA
- Gap above MA, holds = Bullish
- Gap below MA, fails = Bearish
- MA as magnet
- High probability setups
MA Convergence
- Multiple MAs converge
- Big move coming
- Direction uncertain
- Prepare both sides
News and MA
- Bad news, holds MA = Bullish
- Good news, fails MA = Bearish
- MA more important
- Trade accordingly
Key Takeaways
Moving Averages:
- Upper indicators on price chart
- Smooth price to show trend
- Dynamic support/resistance
- Multiple types and periods
- Foundation of technical analysis
- Guide entries and strikes
- Simple but powerful
Moving averages are the option seller’s roadmap, clearly showing trend direction and providing objective levels for entries and strike selection. These upper indicators remove emotion from trading by defining whether to be bullish or bearish based on simple price position. Master moving averages to build a solid foundation for all other technical analysis. Remember: the trend is your friend, and moving averages show you who your friends are.