A moving average is commonly used in the technical analysis of stocks and stock markets. It is precisely a stock indicator for traders, which is derived from the average of stocks or securities over a specific time. Moreover, the moving average helps in knowing the trends on a chart during fluctuations or volatility. Thus, the power of moving averages is immense for astute investors.
It helps in smoothing out the price data of stock. It is done by continuously updating the average price. Hence, it is valuable for traders while they start trading.
By using the moving average, the effect of short-term fluctuations on a stock’s price can be chickened out over a period.
Precisely, moving averages are used to identify the selling and buying opportunities in the unpredictable market
Insight Into Moving Averages
By monitoring moving averages over a specific time, a trader acknowledges the resistance and support levels for a stock. These points assist market players in selling, buying, and bidding on different stocks. The trend direction is essential to garnering returns from an investment.
A moving average is dependent on the prices of the past. Therefore, it is also called a lagging indicator. So, the lag is directly proportional to the period. So, a 20 day MA will have a lesser lag than a 100 day MA.
Notably, the most commonly used moving averages figures are 50 days and 200 days. These are the standards followed by traders and investors globally. It is because they consider them as vital trading signals.
Customize Moving averages
The MA indicator is customizable. So, a trader or investor is free to use any time frame for calculating the average. It provides flexibility for a market player to experiment with different strategies. The commonly used time periods by novice to experienced traders are 100, 200, 15, 30, 20, and 50 days. The shorter time span would create sensitivity to price changes. So. longer time periods should be preferred for the lesser sensitivity.
The trading objective and planning are other reasons why people use different periods of varying length. For example, long-term moving averages are for long-term investment, while short-term moving averages are for short-term investment.
However, a beginner trader would find setting up a specialized time frame for moving averages difficult. So, it can be a random or not-so-popular one. It is the experimentation that helps in understanding a user what suits them. One has to keep on trying before reaching the final set of a time frame suiting their strategies.
Prediction is not simple
To predict the market’s trend or movement, one has to learn the nuances of the stock market. Thus, it is a challenging but necessary process for earning huge returns on investments. However, the possibility of predicting the future market accurately tends to be zero, but with technical analysis, indicators, and research, one can reach better predictions.
A declining or receding moving average exhibits a downtrend in the stock market or a stock, while the increasing or surging moving average represents an uptrend in the security market.
Likewise, an upward moment gets confirmed by a bullish crossover. It happens when the long-term moving average is crossed from above by the short-term moving average. Thus, upward momentum occurs. On the other hand, the bearish crossover confirms the downward momentum. It takes place when the long-term moving average crosses over the short-term moving average.
Moreover, moving averages are handy as the basis for several other technical analyses viz MACD(Moving Average Convergence Divergence).
Use of MACD
Investors and traders use the MACD to monitor the relation between two different moving averages. For calculating it, a twelve-day moving average is subtracted from a twenty-six-day moving average.
It is positive when the position of the short-term average is above the long-term one. Thus, it gives a clear indication of an upward trend or momentum. Meanwhile, it signifies a downward trend or momentum when the long-term average is above the short-term one.
Also, several traders look for movement below or above the zero lines. When it crosses below zero, the signal is for selling, while when it is above, it indicates buying.
Types of Moving Averages
The Moving Averages can be classified into different types as per the utilization of traders.
- Weighted Moving Average
- Exponential Moving Average
- Linear Regression
- Double Exponential Moving Average
- Time Series Forecast
- Triple Exponential Moving Average
- Simple Moving Average
- Wilder Moving Average
- Displacing Moving Average
Simple Moving Average
A simple moving average is also called an arithmetic moving average. For calculating it, traders or analysts can pile up recent prices and divide it by the specific timeframe. It will deduce the average price of closing. For instance, a trader can pick the closing prices of a stock for 50 days and add them. For knowing the average, it should be divided by the number of periods.
The reason it is called moving is that stock prices change continuously over a period. Thus, you observe changes in moving averages simultaneously. You can use the following formula to calculate the simple moving average:-
SMA= P1+P2+P3+P4+…..Pn / n
Here n= number of time frames
P= closing prices for each day
Exponential Moving Average
The purpose of the EMA (Exponential Moving Average) is to track an investment’s price. It is a technical chart that works as an indicator. The investment can be into commodities or stocks, or any other financial asset. It emphasizes the current price data. It also witnesses the price trends over a period. Moving average ribbons are used for monitoring several EMAs at a time.
The EMAs are designed to witness the price trends over certain time frames, like 20 days or 50 days. Therefore, a multiplier is added to the simple moving average for computing the EMA.
EMA=k × Price(t)+(1−k)× EMA(y)
Here, Y= yesterday
N= EMAs days
Weighted Multiplier (WM)= 2÷(1+selected time period)
For calculating EMA, an analyst has to go through three different ways:-
- Computing the simple moving average
- Calculating the multiplier for weighing the EMA
- Calculation of the current EMA
Double Exponential Moving Average
The DEMA or Double Exponential Moving Average was introduced to the world by Patrick Mulloy. Its purpose is to diminish the noise emanating from different price charts used by investors and technical traders. For eliminating the lag, it uses two EMAs. Interestingly, some traders consider lag as an issue.
The usage of DEMA is similar to the MA. When the price goes above the average, it helps in confirming uptrends. Likewise, when it goes below the average, it confirms downtrends to traders.
Notably, if the price changes are nearer, the DEMA reacts quickly that helps investors. However, it contains less information as the information here is smoothened twice.
For accessing the trend analysis and direction, traders monitor prices relative to DEMA. Moreover, it helps in knowing the trend’s strength.
Traders have an option of using two or more DEMAs with distinct look-back periods mentioned on their charts. It is also used for marking the potential resistance and support areas.
Triple Exponential Moving Average
TEMA or Triple Exponential Moving Average helps in smoothing the price fluctuations. Thus, it makes it easier for traders to identify the trends without lags that are associated with normal or traditional Moving Averages.
It takes multiple EMAs (Exponential Moving Averages) for doing that and subtracts it with the lag. TEMA is used in a similar way to other MAs. it provides signals for trends changes, identifies the trend directions, suggests pullbacks and offers resistance and support. It is closely linked with DEMA. So, one can compare that with it.
When the price is low, TEMA confirms a downtrend, and when the price is up, TEMA confirms an uptrend. Hence, in many ways, it is similar to other moving averages.
The reaction of TEMA to price changes is quicker than traditional EMA and MA. However, there’s a disadvantage in that it does not immediately change the indication and angle when the price alters its direction.
When prices of securities fluctuate more than normal, and it moves back and forth quickly, it provides less insight. Also, the signals that it provides are mostly false during crossovers.
Disadvantages associated with Moving Averages
Moving averages come with several charting applications. They promise the easiest and simplest way to acknowledge the trend in a commodity, stock, and other markets. However, that is not always true. Additionally, there are several weak points that are working against traders.
So, moving averages do not offer exact indicators. One may find several loopholes.
- Moving Averages can only draw trends by using the information of the past price information. So, that’s one of the leading constraints for traders. Moreover, they do not consider the changes in fundamental factors that may have a huge impact on a security’s price changes or performance. It includes new policies, new industry products, revenue earned of the company, rising competition, etc.
- You cannot apply uniform rules or parameters to judge or identify the trends of each security. It is due to the unique price histories carried by every asset.
- Any time period can be used for spreading the moving averages. However, it may be different from the general trend due to the time period used. Thus, that’s a big issue.
- There’s a dilemma whether the recent days should be prioritized in moving averages over the old ones to reach the nearest accuracy of trends. Many experts believe that the recent data shows the direction of the trend.
- There are arguments by several investors that moving averages are meaningless in trading as they do not speculate the market behavior at all. Also, they believe that the past cannot judge the future of the market.
- Moving averages fail to capture the cyclical behavior of financial markets. So, when the fluctuations are bigger, moving averages fail to get the meaningful trend.
- If the security is not moving in any direction, the usage of moving averages fails entirely. So, there’s no chance of earning profits from selling or buying. Thus the primary purpose of these averages fails to amuse users.
Moving Averages are powerful indicators for traders who can keep their calm in the market and use good brokers like ABinvesting, TradedWell, PrimeFin, HFTrading, and Brokereo. MA is used in technical analysis through which traders and investors can decide on their future investments. In addition, they can successfully speculate the market trends and see how the market grows. However, there are a few drawbacks that need to be managed by traders.
What is the use of moving averages?
The primary purpose of moving averages in technical analysis. It helps traders understand the significance of the price movement and earn from the trend patterns of indices and securities. In addition, analysts use it for determining whether the change occurred for security. So, if there’s some upward or downward movement, they’ll know about that. Finally, it helps in creating strategies.
What are moving averages in a stock market?
In the stock market, it helps in acknowledging the average price of a stock over a time frame or a span. Based on that, a trader can use strategies for future investments. It aids in mitigating any losses and reaping great returns on investments.
Which is the best moving average?
The moving average is based on the objective of a trader. Thus, it depends. However, anything between 50-days to 200 days is considered the best as traders have enough time frame for knowing about a stock’s performance. Investment becomes easy for traders as the prediction is simple.
Is moving average good for traders?
Moving averages are popular among traders as they help them negate the unnecessary noises and iron out the issues related to trading.
What are the types of Moving Averages for traders?
Some of the moving averages are:-
- Exponential Moving Average
- Triple Exponential Moving Average
- Simple Moving Average
- Wilder Moving Average