Introduction to Trading using Moving Average
Technical indicators like moving averages assist traders spot trends and buy/sell opportunities. To better understand market activity, it smooths price data over a particular time period.
A Moving Average?
The average price of a securities over time is used to generate a moving average. A trader may choose between minutes and days. A line on a chart shows the average price movement during that time period.
The Simple Moving Average (SMA) and Exponential Moving Average (EMA) are the most prevalent moving averages. The SMA weights all data points equally, while the EMA weights recent prices higher, making it more market-responsive.
Calculating Moving Average
Moving averages are easy to calculate. Consider a 5-period simple moving average.
1. Collect pricing data for the given time period (5 days).
2. Add daily pricing.
3. Divide total by days (5 in this example).
4. Chart the day’s average.
5. Drop the oldest data point and add the newest when new data becomes available.
Say a stock’s 5-day closing prices are:
Day 1: $10
Day 2: $12
Day 3: $11
Day 4: $14
Day 5: $13
For day 5, compute the simple moving average:
(10 + 12 + 11 + 14 + 13) / 5 = $12
Using Moving Averages to Trade
Moving averages have several trading applications. Some typical methods:
Finding Trends:
By drawing a moving average on a chart, traders may determine trend direction. Price continuously above the moving average indicates an uptrend, while prices below it signal a downturn.
Crossover Strategy:
Shorter-term moving averages crossing longer-term averages are crossovers. This may indicate a buying or selling opportunity. The shorter-term moving average crossing above the longer-term moving average may represent a bullish signal, recommending a purchase.
Levels of Support and Resistance
Moving averages may support and resist. In an upswing, the moving average may avoid price drops. The moving average may prevent prices from climbing in a decline.
References and sources:
1. Investopedia: https://www.investopedia.com/terms/m/movingaverage.asp
2. Forex.com: https://www.forex.com/en-us/education/themes/technical-analysis/moving-averages
3. StockCharts.com: https://school.stockcharts.com/doku.php?id=technical_indicators:moving_averages