Moving Average Period Meaning
The length of a moving average period, or simply moving average period, means how many bars are used for calculating the moving average. When you are selecting a moving average period length, you are deciding how far back to the history you want to look.
For example, a simple moving average with a period of 10 will be calculated by adding up the closing prices of the last 10 bars and dividing the sum by 10. The result, the value of the moving average, represents the average closing price of the last 10 bars. If your time frame is 5 minutes, this moving average represents the average price in the last 50 minutes. If you use daily charts, it represents the average closing price in the last 10 days (2 weeks).
Period Length Is the Most Important Moving Average Parameter
There are three basic parameters you can set with moving averages. Besides the period length the other two are:
- the price used for calculation (e.g. close, or average of high and low)
- the type of the moving average (e.g. simple or exponential)
Of these three parameters, the length of the moving average period will in most cases be the most important. If you are new to moving averages, try to put two simple moving averages on your chart (not important which security it is). Set the period of one moving average to 10 and the period of the other moving average to 200. The difference is huge.
Moving Averages Lag Behind Price
A short period moving average (e.g. 10) will track the price closely almost all the time. On the contrary, a long period moving average (e.g. 200) will often divert far from the price and stay away for extended periods of time. You will notice that the long moving average lags behind the price – it always goes in the same direction as the price, but takes a bit more time to get moving. In fact, all moving averages lag behind price. The longer the period length, the greater the lag.
Best Moving Average Period?
So is it better to use short moving averages, because they are faster? Or are there any benefits of using long period moving averages?
Like there is no “right” way to do many things in finance and trading, there is also no “right” moving average period.
Advantages of Faster Moving Averages
Most people who like trading are naturally attracted to tools that seem to work faster and show more action. That’s why we tend to play with insanely short timeframes for daytrading (have you already tried a 10 second or 10 tick bar period on the S&P500? Very exciting – but quite useless, at least in my case.) With moving average period selection it is similar as with bar periods.
Especially if you are a short term trader, you probably feel the urge that you must react as quickly as possible to stay ahead of the markets. You probably want to catch every new trend in its very beginning.
Disadvantages of Faster Moving Averages
The problem with being very fast is that you will also be wrong often. The faster you decide about entering a potential trade, the less time you have for the decision, and the less information you have available at the moment of making it.
If the trend proves to be a good one, you will most likely make more money on it if you enter soon. But on price moves which first look like something big is going to happen, while a moment later the move fades, waiting a little bit longer with your decision could have saved you from entering a losing trade.
Long or Short Period… That Is the Question.
The best you can do is to decide in advance if you want to be the fast-yet-often-wrong trader or the thorough-analyst-who-misses-some-good-trades. There is a trade-off and there is no way around it – you can’t be the good part of both (and if you try to be both, you are more likely to end up as the bad part of both). One approach is not by default better than the other.
A good way how to look at it is: How many times per day (month, year – depends on your time horizon) do I want a meaningful information from the moving average? Or in other words, how often do I want to get a trading signal?
How to Pick the Best Moving Average Period for Me?
In ideal case you will research your market’s history and find out the usual rhythm of the market and the typical length of trends and moves in the market. For example, you are daytrading the S&P500 futures and by studying the past (looking at the charts of intraday price development in past days) you conclude that a typical intraday trend on the S&P500 lasts about 25 minutes. So you decide you want to use 25 minutes of history for calculation of moving average on each bar. Just divide 25 by the length of each bar (the time frame you are displaying on your chart) and you get the number of bars you will use for calculating the moving averages (the moving average period). Examples:
- You work with 5 minute bars – you set the period of your moving average at 5 bars.
- You work with 1 minute bars – you set the period of your moving average at 25 bars.
- You work with 3 minute bars – you set the period of your moving average at 8 bars. I know that 3 times 8 is 24, but such difference does not really play any role here.
Markets Keep Changing
In reality, and especially in a market like S&P500, the ideal moving average period length or the rhythm of the market changes from day to day, and even from hour to hour. In ideal case you will always use the ideal length of the moving average and you will always just nicely catch every trend and stay away from every trap, as your miracle moving average would show you. The problem is that you never know in advance what the rhythm of the market will be. If we could see the future, trading would be so easy.
Choose a Period and Let It Show You If It’s Good
So the best thing you can do if you want to use moving averages is to pick a period that works often, as there is no period that would work always. Furthermore, what works for one person, may not work for other person.
So I suggest you now don’t start googling for “the best moving average period”, as doing so will be a waste of time. Put on some length, use it for some time, and you will soon know by yourself if that period is too slow, too fast, or a good one for you.
One final note: the 25 minute period on S&P500 was just an example (first number which came to my mind while writing). It may or may not be suitable for you.