What Are Moving Averages?

  • Moving averages are often the first technical indicators traders are exposed to, specifically the simple moving average. This blog post looks at the purpose of simple moving averages and how traders can customize them to their trading strategies
  • Moving averages were developed to give investors and traders a less noisy view of how the value of a security has changed over time. While the value of a stock can vary widely in a single day, the value of a moving average is comprised of several closing prices, thus removing short term volatility.

Note the year to date chart of Ford below with a 50 day simple moving average. Traders can quickly garner insight into the company’s trend with the average and not be distracted by short term fluctuations.

Different Moving Averages

  • The simple moving average is the most widely of the moving average indicators. It is calculated by adding the chosen number of closing prices and dividing by the number of data points in that period.
  • One criticism of the simple moving average is that it takes a long time to respond to substantial price changes. For example, in the Ford chart above, shares have fallen 6.8 percent over the past three weeks but the simple moving average has just started to respond. To overcome this weakness, the exponential moving average is used.
  • The exponential moving average gives more weight to the latest prices, thus making it more responsive to short term changes. The exponential moving average is used to construct the MACD indicator. In short, the MACD uses different periods of time in the exponential moving averages to signal upswings and downturns in price.

Short Term Changes

  • Although the exponential moving average is more sensitive to short term changes, investors can customize their ideal amount of volatility exposure by changing the number of periods used and length of periods.

50 is arguably the most often used number of periods for a moving average calculation. However, by shortening the number of periods (20 is popular) the moving average will greater reflect short term fluctuations. By lengthening the number of periods (200 is popular), traders can remove a significant amount of noise from the market.

The periods in the calculation do not have to be days, but can be weeks, hours, minutes, etc. By choosing a shorter period, traders can more easily identify a security’s short term trend. For example, a one minute period may be used for insight on a stock’s single day trend.

Lime Brokerage LLC is not affiliated with these service providers. Data, information, and material (“content”) is provided for informational and educational purposes only. This content neither is, nor should be construed as an offer, solicitation, or recommendation to buy or sell any securities. Any investment decisions made by the user through the use of such content is solely based on the users independent analysis taking into consideration your financial circumstances, investment objectives, and risk tolerance. Lime Brokerage LLC does not endorse, offer or recommend any of the services provided by any of the above service providers and any service used to execute any trading strategies are solely based on the independent analysis of the user.

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