What is Moving Average| How it works in stock market| How to use moving average in stocks market
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Moving Averages
Moving averages are one of the most widely used groups of technical indicators.They present a smoothed version of the price action of a stock, commodity,or currency, so investors can more easily see the general price trend.
Moving averages are usually constructed from closing prices, but this is not always the case. They are normally created from prices that are spaced at equal time intervals.
Order of Moving Averages
The location of moving averages in relation to one another can also be considered a signal. For example, some traders seek out situations where a stock’s 10-period SMA is above its 20-period SMA. In turn, the 20-period SMA should be higher than the 50-period SMA, and the 50-period SMA should be located above the 200-period SMA. Taken together, the moving averages would align in the following order:
10 > 20 > 50 > 200
This was confirmed by the stock’s moving averages, which were aligned in the proper formation (10 > 20 > 50 > 200) for an uptrend.
In the case of a downtrend, the concept remains the same but the order of the moving averages would be reversed.
The following is considered the correct order of moving averages for a downtrend:
200 > 50 > 20 > 10
Moving Average Support and Resistance
Moving averages are useful tools in trending markets. They sometimes act as support or resistance within a trend, in this sense, they are similar to trend lines. However, there is one important distinction: Moving averages are created by a computer program that, one would assume, is completely objective.
The program isn’t seeking to place a trade and doesn’t have a biased opinion about a particular investment. Trend lines, on the other hand, are usually drawn by the human hand, and therefore can be subjective when compared to moving averages. If you ask ten people to draw a trend line on a chart, you just might get ten slightly different trend lines. However, if you ask ten people to place a 50-day SMA on a chart, all ten should arrive at the same result.
Moving Average Trading Signals—Single Crossover System
Traders also use moving average crossovers to create buy and sell signals. One such example would be a 50-day SMA crossing above a 200-day SMA on a daily chart. When the 50-day SMA crosses above the 200-day SMA, the crossover is popularly known as a ‘‘golden cross’’ and is considered bullish.
When the 50-day SMA cuts below the 200-day SMA, it is referred to as a ‘‘death cross’’ and is considered bearish. Some technical analysts insist that both moving averages should be rising for the golden cross to be considered legitimate, and that both moving averages should be falling in order to create a genuine death cross. Others define these terms in a less rigid manner.
Moving Average Trading Signals—Multiple Crossover Systems
One problem with the golden cross and the death cross is that they produce infrequent signals. To counteract this, traders use a variety of combinations involving shorter moving averages to create more frequent signals.
One variation on this theme has investors using the 4-period, 9-period, and 18-period moving averages to create buy and sell signals. The buy signal occurs when these moving averages are aligned in the following manner: 4 > 9 > 18
Other Types of Moving Averages
There are other types of moving averages beyond the SMAs. The other types include linear weighted moving averages and exponential moving averages, which are discussed next.
Linear Weighted Moving Average
Up to this point, we’ve used SMAs in all of our examples. Now I’d like to introduce another type of moving average known as a ‘‘linear weighted’’ moving average (LWMA). When we constructed our three-period SMA at the start of this chapter, we gave an equal weighting to all three time periods used in the calculation.
However, it is possible to give a greater weighting to some time periods and a lesser weighting to others. The LWMA places greater emphasis on the most recent time periods and less emphasis on older time periods.
The greatest weight is placed on the most recent time period, and each successive period has a lesser weighting; in other words, the
weighting of each time period is reduced in a linear fashion. In the case of a weighted three-period moving average, the newest time period would have a weighting of three; the second newest would have a weighting of two, and the oldest time period would have a weighting of one.
weighting of each time period is reduced in a linear fashion. In the case of a weighted three-period moving average, the newest time period would have a weighting of three; the second newest would have a weighting of two, and the oldest time period would have a weighting of one.
The reasoning behind this is that since the older time periods will soon fall out of the equation, they are treated as less significant than the more recent time periods. Why would one do this? This emphasis on more recent time periods causes the weighted moving average to react more quickly to changes in price than its SMA counterpart.
Note that this doesn’t necessarily mean that the weighted moving average is superior to the SMA.
Exponential Moving Averages
An exponential moving average (EMA) is a type of weighted moving average, since it places greater emphasis on recent prices than it does on past prices. However, it differs from a LWMA in an important way. While the older prices fall out of the calculation of an LWMA, they are still part of the equation of an EMA.
The EMA calculates all of the historic ranges from a specific starting point. It takes new prices and combines them into the previous average. Because of this, older prices remain part of the equation.
This difference makes the EMA a smoother, slower version of an LWMA. The net effect is that an EMA tends to react more quickly to price than an SMA, but less quickly than an LWMA.
So we can say that a moving average can be applied to almost any set of numbers. An individual could create a moving average of their net worth or of the time spent each week performing a task, such as gardening. In trading, moving averages are useful in trending markets. They present a smoothed version of the price, eliminating extreme high and low points.
FAQ
Q-1 Which is the best moving average for monthly charts?
Ans:- 5 SMA
Q-2 Which moving average is used to know top and bottom of stock market?
Ans:-124 DSMA on weekly chart .
Q-3 Which moving average is best for investment?
Ans:-13 EMA on weekly chart.