A stock's Moving Average is a mathematical tool used by technical analysts and chartists to smooth out erratic price data
over a given period of time. It is simply an average of a stock's closing price over a selected span of time selected by the
individual for study.
For instance a 5-day moving average of a stock would be the most recent 5 closing prices added together and the sum then
divided by 5. When another day is completed for the stock price, the new closing price is added to the list and the oldest
number is dropped off and the calculation is repeated.. hence the term "moving average".
As Alexander Elder says in his 1993 book, Trading for a Living, "A moving average shows the average consensus of
value during its time window. A 10-day MA represents the average consensus of value for the past 10-days, a 20-day
MA for the past 20-days, and so on."
For a more detailed explanation of moving averages you can read the following article: Wikipedida - Moving Averages
Four Ways To Use Moving Averages
As A Visual Reference Point On Chart
To Determine Uptrend/Downtrend Of Price
Crossovers Of Two Or More Averages
Support and Resistance Levels
Price Targets, Price Magnets
Price Crossing A Key Moving Average. A tried and true method of using moving averages is
to watch for the price to cross the average and the slope of the average to change. In the example below you will notice the price first
crosses above the 13-period SMA and then the average begins to slope up. A signal is given to
go LONG. As long as the price can stay above the moving average and the line remains pointing up the conditions
are considered "Bullish" or strong. When the price drops below the moving average and the average begins to point
down conditions are shifting to "Bearish" or weakness and a Sell or Shorting signal is given. This is a very simple,
but time-tested approach to using a moving average. The technique can work on all time frames from daily to weekly
to intraday price bars such as the 1 hour bar or 5 minute bar.
Price Responds To A Key Moving Average As Support Or Resistance. Many moving averages act as
support in and uptrend and resistance in a downtrend. A good example of this is the 50-day Simple Moving Average. (See Example Below)
When a stock is trading above an upward sloping 50-day SMA it will many times pullback exactly to the moving average before
bouncing and continuing higher. This can present a good buying opportunity. Other key moving averages that have this effect can
be the 100-day SMA, the 200-day, and the 10-week, 30-week, 40-week SMAs on the Weekly timeframe. On the intra-day timeframe, lets
say off a 5 min. chart you will see this same kind of behavior off of 30-period SMAs, 89-period SMAs. Many other moving averages
can have this affect as well.
Two Moving Averages Of Different Lengths Cross.
The Dual MA crossover is one way to use moving averages in a more sophisticated way. The rules are still
quite simple. The chartist chooses 2 moving averages of differing lengths, i.e. a fast moving average and
a slower moving average. When the fast moving average crosses ABOVE the slower moving average this alerts
for a potential buy signal. When the fast moving average crosses BELOW the slower average this denotes
a sell or shorting alert. An example of this, (See Chart Example Below) - would be an 8 per. SMA and a 12 per. SMA combination. Other
popular combinations are the 20-day SMA crossing the 50-day, the 50-day SMA crossing the 200 day, the 10-week SMA
crossing the 40-week, etc.
According to the well known author and trading researcher, Jake Bernstein the technical analyst
should use an 8 to 1 ratio when choosing a dual moving average pair. For example, if you were going to use a 5-day SMA of closing prices for the first MA, than you would would
want to pair that with a 40-day SMA for the second moving average. The main purpose of using two Moving Averages, is to slow down the response time in a potential
price reversal and cut down on the number of potential false signals.
The Exponential Moving Average. Another popular type of moving average that is used by traders is known at the Exponential Moving Average
which employs a formula to give extra weight to the more recent price action. So in effect, the EMA assigns more significance to the most recent
price action and lesser significance to the prices further back in time in the equation. This makes the moving average MORE SENSITIVE than the Simple Moving
Average and it tends to hug the price trend more closely.
Here you will find a useful article with a short video about Exponential Moving Averages: Investopeida Article About EMAs
More Useful Information On Moving Averages
Larry Conners & Matt Radtke have attempted to statistically quantify moving average performance in swing trading in their research:
Moving Averages - A Quantified Approach
Here is another resource for Moving Averages: Swing-Trade-Stocks.com
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