If you’re involved in technical analysis, it’s crucial to understand the basics of the moving average concept. Keep reading to find out the moving average definition and learn how this tool works!
What Is A Moving Average?
A moving average is a simple technical analysis tool that averages the price of an asset over a specific period, smoothing out its fluctuations and helping to identify trends. Its name derives from the fact that it’s constantly updated as new prices are added and the old ones are dropped from the calculation.
What You Need To Know About Moving Averages
Let’s say you want to calculate a 10-day moving average for a stock. To do it, you could take the average of the stock’s closing price for the past 10 trading days. With each passing trading day, you would drop the oldest price from the calculation and add the most recent one, creating a new average for the next 10-day period.
Moving average calculations can use any type of price data, including the closing price, opening price, or even the high or low of each trading day. They can also involve any time period, depending on the investment horizon and trading strategy.
There are three types of moving averages:
- Simple (SMA) – basic moving average type, calculated by taking the sum of closing prices over a given period and dividing it by the number of periods.
- Exponential (EMA) – gives more weight to recent prices compared to older ones, making it a great tool for short-term trading strategies.
- Weighted (WMA) – assigns weight based on the position of the data point in the time series, which means that it is better suited for smoothing out long-term trends.
Overall, if the price of an asset is above the moving average, it’s generally considered a bullish signal. Conversely, the price below the moving average usually signals a bearish trend.
Remember that moving averages shouldn’t be used in isolation but rather in conjunction with other TA tools, such as trend lines, oscillators, and volume indicators, to reduce the likelihood of false signals.
