The term 'Moving Averages' is included in the Economics edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Choose your edition here...
Moving Averages are an indicator that is heavily used in technical analysis. They represent average prices spread out over a period of time. They are more useful because the changes in price action are smoothed out as any random price movements become filtered out.
There are a number of different variations. Two of them prove to be the most commonly used. These are the simple moving average, or SMA, and the exponential moving average, or EMA. A simple moving average is a straight average compiled over a certain number of different time periods. With the Exponential Moving Average, prices that are more recent tend to have a greater amount of weight given to them than prices that are farther back.
Moving Averages are most commonly used to find the direction of the overall trend. They also help to set the levels of resistance and support. Moving averages are also heavily used to create a number of other technical indicators. One of the better known that is based upon the moving averages is the MACD, or Moving Average Convergence Divergence.
Moving Averages tend to be lagging indicators themselves. This is because programs and charts derived them from historical prices. They are useful even despite this lagging nature. The longer a time frame that an individual considers with a moving average, the bigger the lag will be. For example, 200 day moving averages would lag significantly more than 100 day moving averages and even more than 20 day moving averages.
Different Moving Average time frames are employed depending on the trading needs. Investors who are practicing short term trading will be most interested in shorter time-frame Moving Averages. Investors who pursue long term trading will find longer time frame moving averages to be more helpful.
Many different traders and investors find the 200 Day Moving Average to be a useful and significant benchmark and tool. When there are breaks to the top or bottom it sends major trading signals.
For example, if a 200 day moving average acting as a support were convincingly broken, then the underlying security would likely continue moving down. Conversely, if the same important moving average was functioning as a resistance point, then a break of this average to the topside would likely signal the instrument would continue moving up significantly.
Moving Averages deliver a variety of critical signals for trading by themselves. When two of them cross, it can be even more significant. Moving Averages that are going up demonstrate that the instrument or security is trending higher as part of an uptrend. A Moving Average that declined would show the security to be trending lower and involved in a downtrend.
A bullish crossover is another confirmation of movement to the upside. This happens as a shorter time frame Moving Average crosses over and above another Moving Average that is longer term. Similarly, a bearish crossover signals that there is more momentum to the downside. It happens as the shorter time frame Moving Average makes the cross beneath a Moving Average which is longer term.
Another important usage surrounds supports and resistances. When stocks or other securities are trending up, moving averages function as supports. A shorter term uptrend would look to 20 Day Simple MAs. These are a part of Bollinger Band indicators as an example. The longer term uptrend often looks for support at the popular 200 Day Moving Average.
Conversely when securities trend downwards, these moving averages act as resistances. An interesting point about 200 Day Moving Averages is that they are so widely followed that they work in many cases either as support or resistance simply because so many people watch and give them significance.