Moving averages (MA) are one of the most popular and often-used technical indicators in the financial markets. In simple word, a moving average is an indicator that shows the average value of a stock's price over a period (i.e. 10 days, 50 days, 200 days, etc) and is usually plotted along with the closing price.
The most common applications of moving averages are to identify the trending direction and determine support and resistance levels. One can also say that moving averages are used to smoothen out the ‘noise’ of short-term price fluctuations, so as to be able to identify and define significant underlying trends more readily.
There are five popular types of moving averages (simple, exponential, triangular, variable and weighted moving averages). However, the only significant difference between these different types of moving averages is the weight assigned to the most recent data.
A moving average helps cut down the amount of "noise" on a price chart. Look at the direction of the moving average to get a basic idea of which way the price is moving. If it is angled up, the price is moving up (or was recently) overall; angled down, and the price is moving down overall; moving sideways, and the price is likely in a range. A moving average can also act as support or resistance. In an uptrend, a 50-day, 100-day or 200-day moving average may act as a support level, This is because the average acts like a floor (support), so the price bounces up off of it. In a downtrend, a moving average may act as resistance; like a ceiling, the price hits the level and then starts to drop again.
The price won't always "respect" the moving average in this way. The price may run through it slightly or stop and reverse prior to reaching it. As a general guideline, if the price is above a moving average, the trend is up. If the price is below a moving average, the trend is down. However, moving averages can have different lengths (discussed shortly), so one MA may indicate an uptrend while another MA indicates a downtrend.
A moving average can be calculated in different ways. A five-day simple moving average (SMA) adds up the five most recent daily closing prices and divides it by five to create a new average each day. Each average is connected to the next, creating the singular flowing line. Another popular type of moving average is the exponential moving average (EMA). The calculation is more complex, as it applies more weighting to the most recent prices. If you plot a 50-day SMA and a 50-day EMA on the same chart, you'll notice that the EMA reacts more quickly to price changes than the SMA does, due to the additional weighting on recent price data. Charting software and trading platforms do the calculations, so no manual math is required to use a moving average.
One type of MA isn't better than another. An EMA may work better in a stock or financial market for a time, and at other times, an SMA may work better. The time frame chosen for a moving average will also play a significant role in how effective it is (regardless of type).
Some traders use the moving averages to not only identify index/stock trends but also to determine entry and exit strategies. Crossovers are one of the main moving average strategies. Moving average crossovers are a popular strategy for both entries and exits, while another strategy is to apply two moving averages: one long term and one short term to figure out a trend. When the shorter-term MA crosses above the longer-term MA, it gives a ‘buy’ signal, as it indicates that the trend is shifting .
Stock markets can ride new waves or scale walls of worry all in a day’s work, and that is where technical indicators can make a big difference in trading. A moving average (MA) is one of the commonly used technical tools best known as trend following or lagging indicator, because it is based on past prices. Thus, it can only help to confirm when a change takes place in the trend. When co-related with other technical indicators such as Relative Strength Index (RSI) and Moving Average Co .
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