What is Moving Average?

Moving Average (MA) is the average value of shares’ prices of the given period. Average in Moving Average can be as simple as Arithmetic Mean or more complex like Exponential Average or Weighted Average.

Notion

Generally, Moving Average is specified in abbreviation with its parameters (period length, period unit, type) like Mathematical functions. e.g., MA(4, day, close) represents the average value of the last four days’ close prices.

It is in practice to use “close prices,” “day period” and “simple arithmetic mean” as default configuration unless specified. MA(3) can be interpreted as the simple mean price of the last three days’ close prices.

It is also in practice to specify the period first followed by Moving Average abbreviation. For example, 30 EMA is the same as EMA(30) i.e. last 30 days exponential average price.

Using Moving Average in Chart Tools

Moving Average is plotted as a line in chart tools. Any point value on MA line represents the average of the last n price points (where n = period length). We are picking TradingView for MA demonstration.

MA period unit value is inferred from chart interval settings i.e. if the chart is of 1-hour interval, then MA(9) would be a moving average of 9 hours. Period length, price type (default: close), line color, and line thickness are configurable.

You can select any arithmetic moving average (MA/SMA), exponential moving average (EMA), or weighted moving average(WMA):

  • For SMA: Indicators > Moving Average
  • For EMA: Indicators > Moving Average Exponential
  • For WMA: Indicators > Moving Average Weighted

MA as an indicator

Moving Average smoothen the price volatility of a given period. It acts as a trading tool to determine the trend direction of the share price. If a share is traded above MA line, then the trend is an uptrend else a downtrend.

20 EMA
Prices below MA line collectively indicate a downtrend (red) and Prices above MA collectively indicate an uptrend (blue).

Fast-Slow Moving Averages

Some traders prefer using two MA lines of different period lengths in conjunction for estimating trend direction. Such systems of MA lines are usually termed as Fast-Slow Moving Averages. e.g., 20 MA (fast)- 50 MA (slow), 50 MA - 200 MA. The crossover of the fast and slow MA lines generates Buy-Sell signals.

Fast Slow moving average
Showcase of 9 EMA (blue) - 27 EMA (red).
Blue Arrow represents Buy Signal. Red Arrow represents Sell Signal.
Generally, the ratio of slow and fast-moving average varies from 2 to 5 times. Depending upon trading preferences, different length combinations of MA are used.

Drawbacks

It is a lagged indicator. The more the period length, the more it is slow in generating any indication. It may not work well with high price fluctuations and may produce false signals.

Summary

Moving Average is the average of the shares prices taken for a period. It is used to estimate trend direction. The combinations of Moving Averages can be used to generate buy-sell signals. Moving Average may not be smoothened if the price is volatile which may lead to false signals.

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