Moving Averages

| October 12, 2010 | 0 Comments

Moving averages are a useful tool for investors and traders.

How is it calculated?

Usually software does the calculation of moving averages for you, but if you’re interested in how it’s derived, here it is. Moving averages are found by adding X number of previous close prices and then dividing that number by X.

By coming up with the daily value of this number, you will be able to plot a line. One thing to note though, is that moving averages lag the stock’s real price. So if the price has a sharp movement upward or downward, it will take a while for the moving average to reflect this.

How is it useful?

Because moving averages basically an average, you can tell how well the curent stock’s price is, compared to the past. Therefore, when current prices are above the moving average, it is a bullish sign. When prices are below the moving average, it is a bearish sign.

A buy/sell signal is also generated when two different moving averages lines cross. For example, when a short-term moving average crosses below a long-term one, a sell signal is generated. Conversely, when a short-term crosses above the long-term one, a buy signal is generated.

Of course, you should always confirm your analysis with other indicators and tools before making a trading decision.

What values to use for moving average?

All stock charting software offer you the option the change the value for your moving average line. Usually, three lines are recommended: short-term (20 days), mid-term (50 days), and long-term lines (200 days).

You can see these lines reflected in the chart of Singtel that’s attached below.

ma singtel

The default moving averages are calcuated as “simple” or “sma” lines, which is a simple averaging of all past prices for X number of days.

The problem with these simple moving averages is that they are slower to reflect price changes. An alternative is to use “exponential” or “ema” moving averages. These give more weight to the current changes in price rather than those many days ago.

Tags: , , , , , , , , , , ,

Category: Charting Indicators

About the Author ()

John Tan has been Vice President of BlueTrust Investments Corporation for 6 years since the mid-90’s. He has since moved on, to be a professional full-time trader.

Leave a Reply