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Understand what moving average is, when it is utilised, and the formula used to calculate it.
Tools to Analyse Stocks
If you’re familiar with the stock markets it’s likely that you’ve heard that investors, traders, and all those keeping tabs on the market frequently employ measures to analyse stock prices. Among these measures, fundamental and technical analyses are worth noting. Moving average (or MA) gains credence when considering technical analysis. Continue reading to understand all that the moving average indicator entails.
Defining Moving Average
Moving average can be defined as a tool used to conduct technical analysis such that price data is smoothened with the creation of a constantly updated average price. The average referred to here is amassed over an outlined period of time which may be as per the trader’s choice. It could be 15 days, 40 minutes or even 30 weeks. Incorporating a moving average into your trading routine can stand to be beneficial especially as you have the option to select the kind of moving average you implement. Strategies relating to moving average are fairly popular and can be tailor-made to suit any time frame which is ideal for both, short-term traders as well as long-term investors.
Understanding the Value of Using Moving Average
By employing a moving average, you can reduce the amount of noise on your price chart. By simply looking at the direction of the moving average it is possible to ascertain the way in which the price is moving. In case it is angled upwards, it indicates that the price is moving up overall whereas if it is angled downwards, it indicates that the price is dipping overall. If the moving average is moving sideways, it indicates that the price is likely to be in a range.
It is also possible for the moving average to act as support or resistance. In case of an uptrend involving a 50-, 100- or 200-day moving average, it may take on the role of support level as the moving average takes on the supportive role of a floor such that the price can bounce off it. If, however, there is a downtrend, the moving average may act like a ceiling (or resistance) as the price may hit this level and then begin to drop again.
It is important to note that it isn’t necessary for the price to always respect the moving average in this fashion. There could be plenty of instances wherein the price may run through it to a certain extent or else stop and reverse before reaching it.
Owing to this very fact, as a rule of thumb you can assume that if the price lies above a moving average, the trend is up. On the flip side, if the price falls below the moving average, the trend is down. That being said, MAs are capable of having different lengths owing to which one MA may indicate a downward trend whereas the other may point toward an upward trend.
Taking a Look at Varied Moving Averages
You can calculate the moving average in a number of ways, some of which have been explored below.
Calculating Simple Moving Average (or SMA) - If you wish to use a 5-day simple moving average, you must add up the five latest daily closing prices and divide the number arrived at by five so that you are able to arrive at a new average for each day. By connecting each average, you are able to create a single line that flows naturally.
Exponential Moving Average Formula (or EMA) – Calculations involved are more complex owing to the fact that greater weight is assigned to the most recent prices. Should you choose to plot a 50-day EMA and 50-day SMA on a single chart, it will become apparent to you that the EMA reacts with greater speed to price changes in comparison to the SMA owing to the additional weight assigned to recent price data. As trading platforms and charting software perform calculations, you don’t need to rack your brain to employ moving averages.
It is important to note that one form of moving average isn’t superior to another. Instead, they each gain relevance in different scenarios. This means that in certain scenarios EMA may suit the stock or financial market whereas in others SMA may be more appropriate. Further, the time frame selected for the moving average is also relevant and will impact how effective it is regardless of the kind of MA opted for.
Deciphering the Length of Moving Averages
10, 20, 50, 100 and 200 serve as the most common moving average lengths and can be added to any chart time frame in accordance with a trader’s time horizon. The term used to refer to the time frame selected for a moving average is called its “look back period”. This time frame can impact how effective the moving average is. In order to understand this better, consider an MA featuring a short time frame which will react far more quickly to price changes in contrast to an MA boasting of a long look-back period.
Wrapping Up
The value of a moving average lies in the fact that it helps provide simplified price data as it smooths it out and creates a single flowing line making the trend easier to see. If you wish to learn more about moving averages and simply visit the Angel One website.
Disclaimer: This blog is exclusively for educational purposes and does not provide any advice/tips on investment or recommend buying and selling any stock.
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