However, moving averages can have different lengths discussed shortly , so one MA may indicate an uptrend while another MA indicates a downtrend. A moving average can be calculated in different ways. A five-day simple moving average SMA adds up the five most recent daily closing prices and divides the figure by five to create a new average each day.
Each average is connected to the next, creating the singular flowing line. Another popular type of moving average is the exponential moving average EMA. The calculation is more complex, as it applies more weighting to the most recent prices. Charting software and trading platforms do the calculations, so no manual math is required to use a moving average.
One type of MA isn't better than another. The time frame chosen for a moving average will also play a significant role in how effective it is regardless of type. Common moving average lengths are 10, 20, 50, , and These lengths can be applied to any chart time frame one minute, daily, weekly, etc.
The time frame or length you choose for a moving average, also called the "look back period," can play a big role in how effective it is. An MA with a short time frame will react much quicker to price changes than an MA with a long look-back period. In the figure below, the day moving average more closely tracks the actual price than the day moving average does. The day may be of analytical benefit to a shorter-term trader since it follows the price more closely and therefore produces less lag than the longer-term moving average.
A day MA may be more beneficial to a longer-term trader. Lag is the time it takes for a moving average to signal a potential reversal. Recall that, as a general guideline, when the price is above a moving average, the trend is considered up. So when the price drops below that moving average, it signals a potential reversal based on that MA.
A day moving average will provide many more reversal signals than a day moving average. A moving average can be any length: 15, 28, 89, etc. Adjusting the moving average so it provides more accurate signals on historical data may help create better future signals. Crossovers are one of the main moving average strategies. The first type is a price crossover , which is when the price crosses above or below a moving average to signal a potential change in trend.
Another strategy is to apply two moving averages to a chart: one longer and one shorter. When the shorter-term MA crosses above the longer-term MA, it's a buy signal , as it indicates that the trend is shifting up. This is known as a golden cross. Meanwhile, when the shorter-term MA crosses below the longer-term MA, it's a sell signal , as it indicates that the trend is shifting down.
Moving averages are calculated based on historical data and nothing about the calculation is predictive in nature. Therefore, results using moving averages can be random. One major problem is that, if the price action becomes choppy, the price may swing back and forth, generating multiple trend reversals or trade signals. When this occurs, it's best to step aside or utilize another indicator to help clarify the trend.
The same thing can occur with MA crossovers when the MAs get "tangled up" for a period of time, triggering multiple losing trades. Moving averages work quite well in strong trending conditions but poorly in choppy or ranging conditions. Adjusting the time frame can remedy this problem temporarily, though at some point, these issues are likely to occur regardless of the time frame chosen for the moving average s.
A moving average simplifies price data by smoothing it out and creating one flowing line. This makes seeing the trend easier. Exponential moving averages react quicker to price changes than simple moving averages. In some cases, this may be good, and in others, it may cause false signals.
Moving averages with a shorter look-back period 20 days, for example will also respond quicker to price changes than an average with a longer look-back period days. Moving average crossovers are a popular strategy for both entries and exits. MAs can also highlight areas of potential support or resistance. While this may appear predictive, moving averages are always based on historical data and simply show the average price over a certain time period.
Investing using moving average, or any technique requires an investment account with a stockbroker. Investopedia's list of the best online brokers is a great place to start your research on the broker that fits your needs the most. Hatchett, Robert B. Wade Brorsen, and Kim B. Springer, Cham, The Wall Street Journal. Trading Strategies. Technical Analysis Basic Education.
Your Money. Personal Finance. Your Practice. Popular Courses. Table of Contents Expand. Table of Contents. For example, if the price is above the moving average of the security then this is generally considered an upward trend or a buy. Looking for new trading ideas to jump-start each day? Log In Sign Up. Stocks Market Pulse. ETFs Market Pulse. Candlestick Patterns. Options Market Pulse. Upcoming Earnings Stocks by Sector. Futures Market Pulse. Trading Guide Historical Performance.
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