Tuesday, 8 May 2018

Moving Averages and its Uses

Moving Averages:

The moving averages are lagging indicators. i.e they are trend following indicators, and are used to identify changes in trends. The moving average is a way of calculating the average price of an instrument over a given time span. As prices change over time, the average price reflects the change, but at a slower speed. If the current rice moves above the x day moving average, it indicates a buy signal. Same way, if x days of average move its higher average, buy signal is achieved. The value of x depends on the time frame selected. If the current price moves below the moving average, it indicates a sell signal. The value of x depends on the time frame selected. One must always remember that moving average is designed an instrument’s price trend, not to determine the top or bottom.

When to Use:

  • They are best suited for trend identification and trend following purposes, not for prediction. 
  • Because moving averages are following the market trend, they works most excellent when the security is trending and are unsuccessful when a security moves in a trading range.
  • Moving averages work well only in trending markets or securities. When prices are tending moving averages don’t work well for investors.
  • Key is to find a moving average and combination that will be consistently profitable.

  • Most Popular moving average is 39 weeks, ie 200days average. It said that “ Bulls live above 200DMA and Bears live below 200DMA”.
  • Short term traders may look for 2-3 weeks trend with 21 days moving.
  • Long term investors may look for 3-6 months trends 25 weeks moving average.
  • For Trading purpose, lesser parameter can be used, ie 10DMA or 20 DMA.
  • The advantages of using moving averages need to be weighed against the disadvantages.
  • Moving averages are trend following, or lagging indicators that will always be a step behind.
  • This is not necessarily a bad thing though. After all, the trend is eco friendly and its best to trade in the direction of the trend.
  • Moving averages will help ensure that a trader is in line with the current trend. Traders don’t expect to get out at the top and in the bottom using moving averages.

Use of Moving Average Crossover:

  • When lesser day moving average crosses above a greater value moving average, Buy signal is generated.
  • Shorter periods like 3 & 7 days and 7 & 21 days can be used.
  • Longer periods like 14 & 42 days or more can be used.
  • Use another period of early entry and then move to longer periods for confirmation of continuation of the trend.

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