MOVING AVERAGES
Moving
averages have long been in use when doing technical analysis, and many traders
love them because they offer a great system of filtering the ‘noise’ on the
market from the price fluctuations that are random. It is a type of indicator
that follows a trend also referred to as ‘lagging indicator.’ It is an
excellent indicator when you want to keep track
of the price action in the market smoothly. There are two types of
moving averages - Simple Moving Average (SMA) and Exponential Moving Average
(EMA).
SMA-Simple Moving Average
This moving
average is arrived at after calculating the average price of a stock over a
specified period. For example, you can choose the prices of ten days and then
sum them up and divide by ten to get the 10 days moving average. The popular
ones are 20, 50, 100 and 200 days moving averages.
EMA-Exponential Moving Average
This moving
average tends to apply extra weight on the most recent prices to minimize the
lag. The application of the extra weight in the moving average will depend on
the number of periods present. To calculate an EMA on a specific day, it will be highly dependent on the EMAs of the
previous days. The popular ones are 7, 21 and 50 day EMA.
Moving
averages are used to show the support/resistance levels and thus, are capable
of communicating an uptrend and a downtrend. Moving averages have been used to
develop trading strategies, and the two main ones are price crossover and the
average crossover.
Price Crossover: This will
occur when the prices cross over or under a moving average, thus signaling a
possible change in the trend.
Average Crossover: Here, there
will be two kinds of moving averages; one shorter and the other longer. When
the short moving average crosses over the moving average, it shows that it is
time to make a purchase and vice versa.
Tarun Goyal
(Trainer & Author)
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