What Are Moving Averages?
There are 3 main types of moving averages used as technical indicators. If not specified, "moving average" or "MA" refers to "simple moving averages" or "SMA." Simple moving averages are described on this page. Two other common types of moving averages are weighted moving averages and exponential moving averages.
Average price of a security calculated by adding the closing price of a security for a time period (for example 30 days) and then dividing the sum by the number of days in a time period. For a simple moving average computation, equal weights should be given to each day closing price.
A moving average cannot be calculated until we have a data of “n” time periods data. For example we can’t display 25 days moving average until the 25th day in chart for a particular security.
To calculate a moving average for a specific company, we have to add its closing price for the most recent period say 25 days and then dividing it by 25, this would give us the average of that security over a preceding 25 days. The same procedure should be replicated for the successive days and these points can be plotted in the chart.
Compare a moving average of a security’s price with the security’s price itself.
- The buy signal will generate when the security’s price rise above its moving average.
- It is said to be sell signal when the security’s price falls below to its moving average.
Commonly used moving averages are: 20-period moving average, 50-period moving average, and 200-period moving average. This moving average has a spectacular track record in long term market cycles.
Chart: 20-period, 50-period, and 200-period simple moving average of the closing price of Google (GOOG). Timeframe: 1-day bars, so 20-period = 20 days.
Chart Created with thinkorswim by TD Ameritrade. For Educational Purposes Only.
(Download thinkorswim: http://bit.ly/25ebooktos )
The formula to calculate the Simple Moving Average is mentioned below:
Simple Moving Average =
Where “n” is the number of time periods in the moving average
The most significant element in a moving average is the number of time periods used in the calculation of moving average. In this case, we have to find moving average period that would be consistent with the current trend.
The time period used in the moving average calculation should have to fit into the market cycle we desired to follow. Example: If a security has a 40-day peak to peak cycle, the ideal moving average length would be 21 days.
|Very Short Term||
We can convert the daily moving average quantity into a weekly moving average quantity by dividing the number of days by 5 ( e.g. 200-day moving average is almost identical to a 40-week). If we want to convert the daily moving average into monthly moving average, we have to divide daily moving average by 21 days (e.g. a 200 day moving average is very similar to a 9-month moving average, because there are approximately 21 trading days in a month).
Exponential Moving Average,
Percentage Above Moving Average,
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