What is a moving average in trading?
The moving average is considered to be the basic element of technical analysis. The value of the indicator at all points of determination correspond to the average value of the original function for the past time interval. The tool is needed to fix the underlying trends and smooth out short-term changes in quotes.
The mathematical function is widely used to identify price trends and predict the value of various types of assets (stocks, futures, options, etc.). The tool is suitable for beginner traders who are just starting to study technical analysis. Deep knowledge of mathematics is not required to understand the features of the indicator. To create a moving average chart, use the appropriate function of the exchange terminal. This tool is supported by QUIK, MetaTrader, etc.
Moving Averages in Trading
A moving average is a relatively simple indicator used to find trading signals. The moving average formula can be calculated manually or using software. The indicator is the arithmetic mean of a given range of values fixed at a certain time interval. For example, to calculate a monthly moving average, you would take 30 closing prices of an asset and add them together. The resulting figure must be divided by 30.
To determine a simple moving average, you can use not only quotes fixed at the close of trading. To build a chart, price highs and lows are used. Also, as the initial range of values, asset quotes fixed at the start of trading can be taken.
The final result of the math function is displayed as a curved line. The number of time intervals over which averaging is performed is called the order. This parameter is directly dependent on the trading horizon.
The use of the indicator gives the trader the following advantages:
The possibility of automating the trading process;
High level of accuracy with pronounced price trends;
Multifunctionality;
Simplicity.
To identify signals for the acquisition or sale of an asset, you need to combine the cost and moving average curves. The investment object is bought when the price chart crosses the indicator line from the bottom up. If the curve crosses the moving average curve in the opposite direction, then you need to sell the asset. The disadvantages of the method include some signal delay. Using the indicator with a pronounced sideways trend gives many false market entry points.
Application in Practice
There are various types of moving averages available to traders. One or more indicators can be used to identify trading signals. The key strategy for using mathematical tools is to fix the trajectory of the curve, indicating the current price trend. Transactions with assets must be made in the direction of the indicator movement. The tool can be especially effective for short and medium term forecasting.
The indicator can be used for scalping and intraday trading. Let's consider examples of the practical use of the SMA and EMA instruments, which are most popular among traders.
Most often, simple moving averages are used in market analysis. The standard moving average (SMA) calculated over 200 days can be considered a universal tool. A chart built with longer averaging times will allow you to determine the global trend. Daily trends are easier to find using the exponential moving average (EMA), which has an averaging interval of 5, 7, 13, 21 and 50 days.
A versatile combination of several indicators is the combination of the 50-day and 200-day SMA. In the jargon of traders, such a combination is called a “golden cross”. The acquisition of an asset is made in a situation where the short SMA crosses the long one from the bottom up. Another significant figure is the so-called "dead cross", indicating a global trend change. A trade signal to sell an asset occurs when the 50-day SMA crosses the 200-day indicator from top to bottom.
When using the EMA indicator, you can use the intersections of 3 and 5-day curves as trading signals. Pairs 5-13 and 13-21 also apply. The indicator, in a sense, acts as a support or resistance line for the quotes chart. A signal to conduct a deal usually appears at the point of concentration of points of contact between the cost charts and the indicator line. For a more correct determination of market entry points, it is allowed to use mathematical tools in conjunction with technical analysis figures.
The SMMA indicator is rarely used. It is mainly used to identify long-term trends. The LWMA tool is desirable to use in volatile markets. The indicator is highly sensitive and can be used in times of economic instability.
Thee moving average using to determine the trend
A moving average is a mathematical function that can be used to find an uptrend or downtrend. An upward trend is observed in those situations when the asset value line is above the SMA chart. In this case, the curve of the tool tends upward.
If the asset's value line is below the downward moving average chart, then we can talk about a downtrend. A sideways trend is defined using 3 SMAs calculated over different time frames. The interweaving of the curves indicates a flat. A sideways trend can occur when important economic news is expected or when liquidity is low. Most traders are wary of the flat. Bidders prefer to make deals in the presence of a pronounced trend.
Inexperienced bidders don't always understand how to build a moving average. The problem is solved by choosing the appropriate function and specifying the range of initial time intervals. After that, the exchange terminal software will automatically build the curve.
Types and formulas of moving averages
A simple moving average is the sum of closing prices for a selected time period divided by the number of calculation intervals. The disadvantage of the indicator is an overly generalized interpretation of the information. The function is calculated like this:
SMA=Sum(F[i], x)/x
The weight significance of closing prices in calculating the SMA is considered to be the same. This approach reduces the accuracy of determining trading signals. To level this shortcoming, smoothed weighted moving averages are used. The indicator is calculated this in the following way:
SMMA(i)=(SMMA(i-1)*(L-1)+F(i))/L
where:
SMMA(i-1) — smoothed moving average of the past period;
L is the calculated interval;
F(i) — closing cost for the current period;
These indicators from time to time give incorrect signals in case of significant fluctuations in market quotes. An exponential moving average can be used to equalize the obtained indicators. The following equation is suitable for calculating the function:
EMA=(F(i)*L)+(EMA (i-1)*(100-L))
where:
F(i) — market value of closing on the specified time interval;
EMA(i-1) — the value of the moving average of the past interval;
L is the share of used price indicators.
Another important function is the linearly weighted moving average. The calculation of the values of this indicator assumes the assignment of the maximum weight to the last indicators. A linearly weighted moving average is calculated by multiplying closing prices and weighting factors. Indicator formula:
LWMA=Sum(F(i)*i, K)/Sum(i, K)
where:
F(i) — current closing cost;
Sum (i, K) — set of values of weight coefficients;
K is the smoothing interval.
With all the versatility of the described tools, one should not forget that they periodically give incorrect signals. To reduce the volume of unreliable information, filtering is applied using the band and percentage envelope methods. To use the second option, you need to build two moving averages that are above and below the standard SMA curve (the distance is defined as a percentage).
Buy and sell signals appear when the lined up curves cross. The strip method involves building 2 moving averages using asset prices at the time of opening and closing the exchange session. Signals appear when the curves are crossed by the cost graph.
conclusions
Using a moving average allows you to fix trends and determine market entry points. The indicator is very popular among stock players due to its simplicity. Mastering the technique of applying the moving average can be the first step into the world of technical analysis. The tool should not be taken as an absolutely reliable way to determine the current trend.
The accuracy of the forecast can be improved with the complex use of several mathematical functions. When making trading decisions, one should take into account the news background, the general state of the macroeconomics and the financial situation of individual industries. The complex use of elements of technical and fundamental analysis increases the accuracy of forecasts and increases the likelihood of making profitable transactions.
