What is moving average?

29 Jul 2022

If you have been in the market for some time, you may have heard of an indicator called the “moving average”. Today we are going to take a deeper look at the indicator, along with a few examples of how pros use it. This post will also lay the groundwork for future posts about more advanced moving average topics.

Please remember this is an educational post to help all of our members better understand concepts used in trading or investing. This in no way promotes a particular style of trading!

The post will shed some light on the following topics:
- What is a moving average?
- How does moving average work?
- Correct usage along with exhibits

Introduction

A moving average (MA) is a technical indicator that is commonly used to determine the direction of the trend. By continuously recalculating the average based on the most recent price data, a moving average assists in smoothing out the price data. This helps in reducing the impacts of random short-term variations of the price over a given period of time.



Working with moving averages

- Moving averages are typically calculated to determine the direction of the trend and are sometimes used as dynamic support and resistance levels for a given time period.

Exhibit: Moving averages acting as a dynamic support



Exhibit: Moving averages acting as a dynamic resistance



- Since a moving average is derived using historical prices, it is a lagging indicator.

- The lag increases with the length of the moving average. As a result, a 200-period moving average (which includes prices for the previous 200 periods), will lag significantly behind a 100-period MA.

- Likewise, a moving average with a shorter period (faster MA) will be more sensitive to price changes as compared to a slower one.



Usage

- Faster moving averages are typically employed for short-term trading, while slower moving averages are more often utilized for understanding longer-term market dynamics.

- Moving averages are applicable to all time frames. Therefore, experimenting and testing several settings over a range of time frames is the best approach to determine which one works for you.



- A rising moving average indicates strength, while a falling moving average indicates weakness. Hence, in general, a stock is said to be in an uptrend if its moving average is increasing, whereas in a downtrend if MA is decreasing.



- In general, a stock may show bullish momentum if there is a bullish crossover, i.e. when a faster moving average crosses above a slower moving average.



- Conversely, bearish momentum may be expected on a bearish crossover, which occurs when a slower-moving average crosses below a faster-moving average.



Thanks for reading! As we mentioned before, this isn't trading advice, but rather information about a tool that many traders use. Hope this was helpful!
See you all next week. 🙂

– Team TradingView

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