Moving Averages: How To Use Them
A moving average (MA) is a simple technical analysis tool that smooths out market price data by creating a constantly updated average price.
The average is taken over a specific period of time, like 10 days, 20 minutes, 30 weeks or any time period the trader chooses. There are advantages to using a moving average in your trading, as well as options on what type of moving average to use.
Moving average strategies are also popular and can be tailored to any time frame, suiting both long-term investors and short-term traders.
Why use a Moving Average?
A moving average helps cut down the amount of "noise" on a price chart. Look at the direction of the moving average to get a basic idea of which way the price is moving. If it is angled up, the price is moving up (or was recently) overall; angled down, and the price is moving down overall; moving sideways, and the price is likely in a range.
A moving average can also act as support or resistance. In an uptrend, a 50-day, 100-day or 200-day moving average may act as a support level. This is because the average acts like a floor (support), so the price bounces up off of it.
In a downtrend, a moving average may act as resistance; like a ceiling, the price hits the level and then starts to drop again.
The price won't always "respect" the moving average in this way. The price may run through it slightly or stop and reverse prior to reaching it.
As a general guideline, if the price is above a moving average, the trend is up. If the price is below a moving average, the trend is down. However, moving averages can have different lengths, so one MA may indicate an uptrend while another MA indicates a downtrend.
Types of Moving Averages
A moving average can be calculated in different ways.
A five-day simple moving average (SMA) adds up the five most recent daily closing prices and divides it by five to create a new average each day. Each average is connected to the next, creating the singular flowing line.
Another popular type of moving average is the exponential moving average (EMA). The calculation is more complex, as it applies more weighting to the most recent prices. If you plot a 50-day SMA and a 50-day EMA on the same chart, you'll notice that the EMA reacts more quickly to price changes than the SMA does, due to the additional weighting on recent price data.
Charting software and trading platforms do the calculations, so no manual math is required to use a moving average.
One type of MA isn't better than another.
An EMA may work better in a stock or financial market for a time, and at other times, an SMA may work better. The time frame chosen for a moving average will also play a significant role in how effective it is (regardless of type).
Common moving average lengths are 10, 20, 50, 100 and 200. Thes