Moving Average = Probably the Most Widely Used Technical Indicator
Moving averages are among the most widely used technical indicators. I would even say moving average is the most widely used technical indicator, though no one can really know and count this. Moving averages enjoy this privilege thanks to their simplicity, both in calculation (or setup in a charting program) and interpretation. In this article we will explore both.
What Is the Main Goal of a Moving Average?
The main reason why people use moving averages is that the market's price action often gives us too much information – more than we want or are able to process at a moment. For example, when the market is trending upwards and price is growing, the growth is far from a straight line. There are many smaller and bigger dips and congestions. How can you tell whether the market is merely temporarily correcting and will continue to rise soon, or the trend is reversing and a bigger decline is likely?
According to its simplest and most common interpretation, we consider an uptrend still valid if price stays above the moving average. Once price has crossed below the moving average, it is a sign that the trend has reversed to a downtrend.
Moving Average Doesn't Predict the Future
You never know for sure what will actually happen next, but at least a moving average can simplify the information you are getting from the market and help you with fast and clear decision making. Like all other tools in technical analysis, moving average does not predict the future, but it simplifies and quantifies the information about the past.
Simple Moving Average Calculation and Moving Average Period
How to calculate moving averages? The most common type of moving averages, the simple moving average, is calculated just as its name suggests. It is the arithmetic average of the last N bars. N is the so called period of the moving average. The smaller N is, the faster the moving average reacts to changes in price development and the more volatile it appears. For very high N – very long moving average period – the moving average reflects changes in price trends only very slowly and it is lagging behind the price. Both long and short moving averages have benefits and weaknesses.
Most Common Types of Moving Averages
There are several different types of moving averages. Among the most popular are:
- Simple moving average (the one discussed above);
- Exponential moving average;
- Least-square moving average;
- Weighted moving average;
- Adaptive moving average.
All types of moving averages follow the same logic: averaging and smoothing prices. There are only little nuances and variations in the exact calculation of particular types. Calculations of individual types of moving averages are beyond the scope of this article.
If you want to learn more about moving average parameters, you can continue here: Moving Average Parameters.