Moving Average
The moving average is a tool used by traders and investors to view price data and make informed decisions when it comes to investing and trading. Moving averages are used to identify both trends, and potential buy and sell opportunities. A moving average is simply an average of a set of data points over a given set period.
For example, a 30-day simple moving average (SMA) is simply the average closing price of a traded security or asset over the most recent 30-day period. A 50-day SMA would be the average closing price over the most recent 50-day period. By comparing the two, investors and traders can get a sense of the underlying trend for the asset or security, for example if the 30-day SMA is below the 50-day SMA, it indicates a downward trend.
Exponential Moving Average
An exponential moving average (EMA) takes the moving average a step further. It accounts for the latest available data and as such, gives a better indication of the underlying trend than SMA. This is because it gives more ‘weight’ to the more recent observations, and less ‘weight’ to older observations, resulting in a more accurate representation of the underlying trend when compared to an SMA which uses a static, even weight to all observations in the sample.
Like the SMA, an EMA can be calculated using different timeframes. The most commonly used timeframe is the 26-day EMA. This looks at the 26-day period before the current day, and gives more weight to the current day’s price, versus the previous 25 days. An EMA is commonly used in combination with other technical analysis tools like Fibonacci retracements or RSI (Relative Strength Index) indicators. By combining these tools, a trader can gain an even more detailed view of the underlying trend for a specific asset or security.
Using Moving Averages
When trading with moving averages, it is important to use the trendlines to your advantage. A basic trendline will show a buy signal when the shorter-term average crosses above the longer-term average, and a sell signal when the shorter-term average crosses below the longer-term average. Many traders look for multiple crossing of these trendlines before committing to a particular course of action.
It is also important to consider the context of the market when using moving averages. If a security is experiencing a strong, downward trend, the SMA may not be the best indicator to use. Instead, an EMA would be a better tool as it accounts for the most recent price action and provides a more accurate representation of the underlying trend. As a result, it is important to consider which type of moving average best fits your strategy before making a trade decision.
Conclusion
The moving average is a widely used tool for trading and investing. It can help provide a better understanding of the underlying trend of a security or asset, and can potentially trigger buy or sell signals. It is important to be familiar with both the simple moving average (SMA) and the exponential moving average (EMA), as each has its own merits depending on the approach taken by the trader or investor. By combining moving averages with other technical analysis tools, a trader can gain an even more detailed understanding of the underlying trend.
