Moving Averages

Type

Trend Indicator – Moving Averages – Closing Price

How does it work?

Moving Averages are one of the most popular and easy to use tools available to traders and investors.

A moving average is an indicator that shows the average value of a security’s price over a period of time. As the security's price changes, its average price moves up or down.

Using the average of prices, moving averages smooth a data series, making it easier to spot trends. This can be especially helpful in volatile markets. Because past price data is used to form moving averages, they are considered lagging, or trend following, indicators.

There are five popular types of moving averages:

1.      Simple - apply equal weight to the prices

2.      Exponential - apply more weight to the current days value

3.      Weighted - apply more weight to recent prices

4.      Triangular - apply more weight to prices in the middle of the time period

5.      Variable - change the weighting based on the volatility of prices Sharechart shows simple averages on prices and exponential averages on the MACD indicator.

Moving averages can be calculated on any data series including a security's open, high, low, close, volume, or another indicator. Interpreting the moving average on an indicator is similar to that of a securities, when the indicator moves above the moving average, it signifies continued upward movement of the indicator. When the indicator moves below the moving average, it indicates continued downward movement of the indicator. A moving average of another moving average is also common. Sharechart uses a stocks close price to form its moving averages.

Moving averages do not predict a change in the trend, but rather they follow behind the current trend. They are therefore best suited to trend identification and trend following purposes, not prediction.

As moving averages follow the trends they work best when a security is trending and are not effective when a security is moving within a range. Keeping this in mind traders and investors should first identify securities that are trending before analysing with moving averages. 

Trading Signals

To interpret the moving averages for trading and investing purposes, a buy signal is generated when the fast moving average has crossed the slow moving average and is moving above the slow moving average.

A sell signal is generated when the fast moving average has crossed below the slow moving average and is moving below the slow moving average.

This is known as the double moving average crossover with the idea being that the slower moving average is more responsive to price movement, and so acts as the signal to buy or sell. The longer moving average acts as a stable base against the security.

Settings

Shorter length moving averages are more sensitive and identify new trends earlier, but also give more false alarms. Longer moving averages are more reliable but only pick up the big trends.

It is best to use a moving average that is half the length of the cycle that you are tracking. If the peak-to-peak cycle length is roughly 40 days then a 20-day MA is appropriate.

Sharechart Default:  5 period, 10 period, 15 period

Example

The graph below is of Deutsche Industrial Trust and the 2 Moving Averages (MA) show bearish and bullish crossovers. When the short term MA crosses above the longer term MA it is bullish and when it crosses below it is bearish.

The setting for the Moving Averages for the graph above was 5 and 13 periods. It can be modified:  Settings > Indicators > Moving Average Group 1 or Moving Average Group 2.