A moving average is one of the most common technical indicators used by traders. What is a moving average? Add the closing prices over a specified period of time and divide by the number of closing prices in that time frame and Voila! You have a moving average.
Moving averages can be used for a daily chart, weekly chart, yearly chart, intraday chart such as a 5 minute chart.The most common moving average periods are 10, 20, 50, 100, 200. The variations are endless.
For short term trading, many use the 5, 10, 20 and 50 moving averages. A longer term look using the 100 and 200 moving averages give us terms like “Death Cross”. A Death Cross is when the 100 moving average crosses below the 200 moving average after a bull run. The opposite of a Death Cross is a “Golden Cross”.
Moving averages come in a variety of flavors
1. Simple Moving Average(SMA) – used in longer term charts
2. Exponential Moving Average(EMA)– used in shorter term charts
3. Weighted Moving Average (WMA) – rarely used
The most common type of moving average is the simple moving average, which simply takes the sum of all of the past closing prices over a time period and divides the result by the total number of prices used in the calculation. For example, a 10-day simple moving average takes the last ten closing prices and divides them by ten.
The linear weighted average is the least common moving average, which takes the sum of all closing prices, multiplies them by the position of the data point, and divides by the number of periods. For example, a five-day linear weighted average will take the current closing price and multiple it by five, yesterday’s closing price and multiple it by four, and so forth, and then divide the total by five. While this helps resolve the problem with the simple moving average, most traders have turned to the next type of moving average as the best option.
The exponential moving average leverages a more complex calculation to smooth data and place a higher weight on more recent data points. While the calculation is beyond the scope of this tutorial, traders should remember that the EMA is more responsive to new information relative to the simple moving average. This makes it the moving average of choice for many technical traders.(from Investopedia)
Moving averages give trading signals when the shorter term crosses the longer term averages. The better signal is when the price chart is above or below the moving averages and the averages are in order for the direction. Trading when the price is in between moving averages can be choppy and difficult to trade. Pick the A+ trades for the best chance for successful trading with moving averages.
Rob Roy uses moving averages in all of his charting as a primary technical indicator. Learn more about trading and technical analysis in Trading U.