Overview on Moving Average

A moving average is a calculation used to analyze data points by creating subsets of a data set. The moving average or MA indicates stock patterns using a technical approach in the financial market. The moving average calculates the stock average and helps traders smooth out price data by simply creating an updated average price.

Moving Average Meaning

Moving average definition: The moving average (MA) is a technical analysis tool that takes the average price over a specific period. Depending on the trader’s choice, it can take the average over a specific time like 10 days, 20 minutes or 30 weeks, or any period. There are many benefits of using a moving average in your trading technique; there are also many options of moving average to use.

You can tailor the moving average strategies for any period; it is also suitable for long-term and short-term investments.’

The moving average revolves around the impact of random, minimal fluctuation in the price of a stock over a specific time frame.

Why Moving Average?

The answer to why to use a moving average is that moving average helps to narrow down the stock data and analyze the chart with important data points. You can notice the direction of the moving average. If the angle is up, the price moves up. In the opposite scenario, when the angle of MA is moving down, the price goes down. Lastly, the moving is inside; the price is likely in a range.

MA also works as a support or resistance. A 50-day or 100-day moving average in an uptrend acts as a support level for the chart. The average acts like a floor, so the price bounces up. In the case of a downtrend, a moving average acts as a floor to hold the downtrend movement. At the same time, it acts as resistance when the price starts to drop again.

Types of Moving Averages

Now you have understood what is the moving average, let’s understand its types. 

There are two basic forms of moving averages.

Simple Moving Average

The simple moving average is a straightforward technical indicator obtained by using the recent data points and dividing the data points by the number of periods. Traders use this simple moving average as an indicator to generate signals to enter or exit the stock market. The SMA computed different types of high, low, open, and close prices.

In simple terms, we can say that SMA determines whether a trader should buy or sell financial securities. It also identifies the spots of resistance prices and signals where to enter or exit the trade.

To further understand the SMA, we can calculate the average by adding the prices over time.

The formula for the simple moving average is written as follows:

SMA =(A1 + A2+ ………An)/n

A stand for average &  period is denoted by n

And n is the number of periods.

Pros and Cons of Simple Moving Average

SMA is a strong long-term indicator. Volatile small changes will not matter much in the long run, providing a smooth line. A single drastic change in price won’t change the average, removing the outliers and helping you analyze the trade. The very stability it provides is also its drawback. For short positions making trades with the help of the SMA is a bad idea as the reaction of simple moving average changes in them is quite slow compared to price changes. One might not find using SMA for positional or day trading feasible.

Exponential Moving Average (EMA)

In this type of moving average, EMA, the weight is mostly on the recent price to make it more responsive to recent data points. Unlike SMA, the EMA is more volatile to price changes and the period of time.

Calculating the EMA needs to start somewhere, and the simple moving average is used as the previous period EMA.

First, we have to calculate the multiplier for weighting the exponential moving average 

The formula for calculating the multiplier:

Multiplier = [2 / (Selected time period + 1)]

Eg:
Multiplier = [2/ (10+1)] = 0.1818

The last step is to calculate the current EMA by taking the period from the initial EMA until the most recent time.

Current EMA = [ Closing Price – EMA (Previous period) X Multiplier + EMA (Previous Time)].

An upward trend in a moving average might signify the upswing in the price or momentum of a security. 

Today, there is a wide range of formulas to measure and make complex formulas that require a computer program to calculate without error and display data patterns to encourage investors to invest more and work along with the MA information.

Pros and cons of Exponential Moving Average

The benefit of the EMA is that it can help in trading for short intervals. Due to the short time frame it uses, it’s considered a perfect indicator for short positions. Even though it’s a lagging indicator, it can provide relevant and reliable information, which traders can take advantage of. The major reason for this is that the most recent prices are given more importance and have higher weightage painting an accurate average based on new information.

Along with being an advantage, the shorter time frame is also a drawback. High volatility and drastic changes in prices lead to an excessive movement of the EMA. This, in turn, changes its credibility as fake signals are created. Depending on one indicator alone can be harmful, and it can be extremely dangerous in this case.

Example of Moving average

Investors choose different times of various lengths to calculate moving averages based on their trading objectives.  There is no perfect time frame to set up moving averages. You have to experiment with MA with different periods until you find the best suitable MA for your website. 

The short moving average is used for short-term investments, and the longer-term moving averages are suited for long-term investing.

Moving averages calculation has its right, and it can also form the basis for technical analysis indicators, such as the moving average convergence divergence (MACD).

You can consider moving average convergence divergence (MACD) traders monitor the relationship by two moving averages. The calculation of this MA is done by subtracting a 36-day exponential moving average from a 12-day exponential moving average.

Simple Moving Average (SMA) vs. Exponential Moving Average (EMA)

The major difference between the two is their formula and usage. EMA puts more weightage on the recent price movements than the SMA, where each time interval has equal weightage. EMA tends to lead SMA when there is a drastic price change. In case of a fall, SMA tracks it slower while the EMA changes drastically. The simple moving average is best suited for the long position helping you understand the growth as time passes. EMA is more useful for the short term as it pays attention to market volatility. It can be a reliable indicator when it comes to short-term trading.

Conclusion

To conclude, we can say that moving averages is a common way for traders to begin analysis and make decisions based on their research. The most common indicator to add to the chart’s ad serves as a comparison measure with other indicators. A moving average is the average price of a futures contract over time. 

You can also use one or many MA in different frames on one chart. I hope this article is helpful for you to understand the moving average definition, moving average meaning, and what is the moving average.