Moving Average: Simply said, a moving average is the arithmetic mean of a set of data points. The average is calculated over a specified time period, such as 10 days, 20 minutes, 30 weeks, or any other time period that the trader chooses. There are several advantages to using a moving average in your trading. There are many different types of moving averages to select from.
Moving average approaches are popular because they can be tailored to any time period, making them suited for long and short-term investors and traders.
What are the uses of Moving Averages?
A moving average decreases the amount of noise on a chart. Looking at the direction of the MA to get a broad idea of which way the price is heading. If it’s slanted upwards, the price is rising (or was recently); if it’s angled downwards, the price is falling; and if it’s angled sideways, the price is most likely in a range.
Many technical traders use these averages to help them decide where to buy or sell shares, causing these averages to behave as strong support or resistance. In an uptrend, a 50-day, 100-day, or 200-day MA might act as a support level. When the price meets the average, it rises because it serves as a floor (support). In a downturn, a moving average can act as resistance; like a ceiling, the price meets the level and then starts to fall again.
The price will not always respect the moving average. Before reaching it, the price may flow through it briefly or halt and reverse.
Types of Moving Averages
Simple Moving Average(SMA): It is basically an average of the closing rate of the stock for the period of time as decided by the trader. Say, for example, To establish a new average each day, a five-day simple moving average (SMA) sums up the five most recent daily closing prices and divides the total by five. Each average is linked to the one before it, resulting in a single flowing line.
Exponential Moving Average (EMA): Unlike SMA where each price is equally weighted, EMA applies more weight to the recent prices when compared to the old prices. When a 50-day SMA and a 50-day EMA are plotted on the same chart, you’ll note that the EMA reacts to price changes faster than the SMA, owing to the increased weighting on recent price data.
In practicality, The computations are done by charting software and, trading platforms so no manual arithmetic is necessary to utilize a moving average.
Moving Average Crossover:
One of the major strategies is the crossover of moving averages with the price of the stock or between two moving averages
Price Crossover: When a price crosses above or below a moving average, it indicates a possible trend shift.
Moving Averages (MA) Crossover: One of the averages is longer, while the other is shorter. It’s a buy signal when the shorter-term MA crosses above the longer-term MA, indicating that the trend is turning upward, also referred to as a golden cross. Meanwhile, a sell signal is generated when the shorter-term MA crosses below the longer-term MA, indicating that the trend is turning downward also referred to as a dead/death cross.
To conclude, For both entrances and exits, moving average crossovers are a common approach. MAs may also be used to identify possible regions of support or resistance. While this appears to be predictive, MA is always based on historical data and merely displays the average prices of the stock over a period of time.