Beginner’s Guide to Moving Averages

Mon Jun 13, 2022, 08:32 pm | by Azhar Khan | No comments

Moving averages (MA) are one of the most common technical indicators available to traders. This tool comes in many forms: simple, exponential, and weighted. Moving averages make it easier to spot trends on a chart, help find support and resistance lines, and are often used to identify trade triggers.

What are Moving Averages? 

A moving average is a type of technical indicator. It smooths the data and creates an average price over the selected period of time. This means that it will filter out small, short changes in price. The period of time can range from a variety of intervals, from one minute, 1 day, 1 week, 1 month, and more. This type of indicator is very popular and used by active traders and long-term investors.

Read More: Beginner’s Guide: Technical Analysis

Types of Moving Averages

Simple Moving Average (SMA)

Simple moving averages can be calculated by any time frame. It is calculated by taking the closing prices of the desired time frame and dividing it to get an average price. This is not something you’ll likely have to calculate by hand—many trading platforms and charting tools will have this built-in. 

For long-term investors, 50-, 100-, and 200-day MAs are common time frames to use. For shorter-term averages, 5-, 10-, and 20-day moving averages are usually used. 

Exponential Moving Average (EMA) 

Exponential moving averages are calculated by taking the closing prices of the desired time period but giving more weight to the recent prices than the past prices. The benefit of this is that it reacts quicker to price changes. 

Similar to SMAs, these can easily be found in your trading or charting platform. 

Weighted Moving Average (WMA)

Similar to EMAs, weighted moving averages place more weight on the recent closing prices, and less for the older closing prices. The main difference between the two is that WMAs are calculated differently and are more customizable. 

Moving Average Convergence Divergence (MACD)

Moving average convergence divergence, or MACD, is a common technical indicator that is based on moving averages. It measures the strength of a trend and uses two moving average prices. The MACD is the 12-period EMA minus the 26-period EMA.

Why Use Moving Averages 

SMAs, EMAs and WMAs reduce noise on charts by smoothing out the data that may show short-lived price changes. It makes it easy to read and detect trends. 

You can use moving averages when analyzing a stock to highlight its price trend. If the price is higher than the moving average, it is showing you the stock is trading higher during the selected period, on average. If the price is lower than the moving average, it is showing you that the stock is trading lower during the selected period, on average. This can help confirm up or downtrends. 

Some moving averages may also act like support or resistance lines. For example, 50-, 100- or 200-day averages could act as support or resistance lines. 

Some people will combine moving averages and use other indicators to create their own trading signal that fits with their strategy. One example of this is added a short-term MA and long-term MA. If the short-term MA crosses the longer-term MA, you might interpret that as a buy-signal for an uptrend. This is known as a golden cross. Remember to do the proper research on golden crosses before using it as a buy signal for yourself. 

Disadvantages of Moving Averages 

One disadvantage of moving averages is that it is based entirely on historical data—nothing about it gives a reading about the future. Just because the moving average is in uptrend doesn’t mean the stock will continue in that direction.

Additionally, MAs work best in trending market conditions. When the market gets choppy, they are not as reliable.

Final Thoughts 

Moving averages are a helpful tool for traders, making it easier to spot price trends. No matter your trading strategy or style, you probably use a moving average in your strategy and chart analysis.

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