The moving average MA is a simple technical analysis tool that smooths out price data by creating a constantly updated average price. The average is taken over a specific period of time, like 10 days, 20 minutes, 30 weeks, or any time period the trader chooses. There are advantages to using a moving average in your trading, as well options on what type of moving average to use.
Moving average strategies are also popular and can be tailored to any time frame, suiting both long term investors and short-term traders.
A moving average can help cut down the amount of " noise " on a price chart. Look at the the direction of the moving average to get a basic idea of which way the price is moving. Angled up and price is moving up or was recently overall, angled down and 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 day, day or day moving average may act as a support level, as shown in the figure below. 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 it 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. Moving averages can have different lengths though discussed shortly , so one may indicate an uptrend while another indicates a downtrend. If you want to learn how other technical analysis strategies, Investopedia Academy's Technical Analysis Course is an excellent starting point.
A moving average can be calculated in different ways. A five-day simple moving average SMA simply 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 but basically applies more weighting to the most recent prices. Charting software and trading platforms do the calculations, so no manual math is required to use a MA.
One type of MA isn't better than another. The time frame chosen for a moving average will also play a significant role in how effective it is regardless of type. Common moving average lengths are 10, 20, 50, and These lengths can be applied to any chart time frame one minute, daily, weekly, etc , depending on the traders trade horizon. The time frame or length you choose for a moving average, also called the "look back period", can play a big role in how effective it is.
An MA with a short time frame will react much quicker to price changes than an MA with a long look back period. In the figure below the day moving average more closely tracks the actual price than the day does. The day may be of analytical benefit to a shorter-term trader since it follows the price more closely, and therefore produces less "lag" than the longer-term moving average. Lag is the time it takes for a moving average to signal a potential reversal.
So when the price drops below that moving average it signals a potential reversal based on that MA. A day moving average will provide many more "reversal" signals than a day moving average. A moving average can be any length, 15, 28, 89, etc. Adjusting the moving average so it provides more accurate signals on historical data may help create better future signals.
Crossovers are one of the main moving average strategies. The first type is a price crossover. This was discussed earlier, and is when the price crosses above or below a moving average to signal a potential change in trend. Another strategy is to apply two moving averages to a chart, one longer and one shorter. When the shorter MA crosses above the longer term MA it's a buy signal as it indicates the trend is shifting up.
This is known as a " golden cross. When the shorter MA crosses below the longer term MA it's a sell signal as it indicates the trend is shifting down. Moving averages are calculated based on historical data, and nothing about the calculation is predictive in nature. When this occurs it's best to step aside or utilize another indicator to help clarify the trend. Moving averages work quite well in strong trending conditions, but often poorly in choppy or ranging conditions.
Adjusting the time frame can aid in this temporarily, although at some point these issues are likely to occur regardless of the time frame chosen for the MA s. This can make isolating trends easier. Exponential moving averages react quicker to price changes than a simple moving average. In some cases this may be good, and in others it may cause false signals. Moving averages with a shorter look back period 20 days, for example will also respond quicker to price changes than an average with a longer look period days.
Moving average crossovers are a popular strategy for both entries and exits. MAs can also highlight areas of potential support or resistance.
While this may appear predictive, moving averages are always based on historical data and simply show the average price over a certain time period. Dictionary Term Of The Day. Broker Reviews Find the best broker for your trading or investing needs See Reviews. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education.
A celebration of the most influential advisors and their contributions to critical conversations on finance. Become a day trader. Moving Average Length Common moving average lengths are 10, 20, 50, and Trading Strategies - Crossovers Crossovers are one of the main moving average strategies.
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