Moving Averages
Moving Averages are one of the oldest and most popular of technical analysis tools. By using an average of prices, moving averages smooth a series of price data to make it easier to spot trends. This is especially helpful in volatile markets.
Moving Averages are a lagging indicator, always behind the security price it's applied to. As such they are trend following and at their best when following a security price trending either up or down.
You can use one or a combination of moving averages and any period of measure can be chosen, such as a 20 day moving average which shows the average price of the security over the past 20 days or a 200 day moving average which shows the average price of the security over the past 200 days.
Shorter term moving averages will be more sensitive to shorter term movements of the security whereas a longer term moving average will move more slowly, providing more reliable longer term trends.
The number of periods used in a moving average will vary according to the volatility of the security. The more volatility there is, the more smoothing required hence a longer term moving average is preferable. Some of the more popular lengths chosen are 50, 100 and 200 days as well as 10,30 and 40 weeks. The best effect is found by trial and error.
A combination of moving averages are extremely useful, for example combining a shorter term 100 day with a longer term 200 day moving average. A Buy signal can often be when the shorter term average crosses up through the longer term moving average. Likewise the reverse can be true when the shorter term moving average crosses down through the longer term average.
In conclusion, Moving Averages are trend following and assist in identifying both current trends and changes in trend. They are also helpful in identifying support and resistance levels of a security on a chart.
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