Simply put…moving averages are indicators. It helps in finding the trend in the market. Is the market bullish or bearish. Are majority of the people buying or selling at the moment.
For the analytical peeps out there: A moving average (MA) is a line that shows the average of a number of data points on a moving basis like the 20 day or 50 day moving average.
Simple Moving Average gives equal weighing to all prices in the series
Thankfully the system does it for you so you don’t have to manually do the calculation.
For example: A 20 day moving average calculates the average of 20 days of the data in the chart and plots it. Then move 1 day forward by dropping the first day and adding the next day. The average moves forward and so do the line.
Technical Analyst uses moving average to identify trends in the market to help you spot a buy or sell signals no matter if you are trading stocks, bonds, forex or commodities.
Moving average can be classed as simple, exponential , linear weighted or centred. Each has its own calculation and features.
A well-known technique used in the simple moving average (SMA) is the Golden Cross and the Dead Cross."
50 and 200 SMA is used in this technique.
Golden Cross: A signal is "triggered as an alert" when the shorter moving average i.e. 50 SMA crosses above the longer (200) SMA. But most traders fail to follow the CONDITION.
Dead Cross: Sell Alert happens when the 50 crosses the 200
Like any other technique, moving averages has its plus and minus.
Two known disadvantages :
As you can see in the chart above, there are chances of whipsaws.
Mixed signals hence not reliable on a choppy market.
Works best in a trending market.
It’s always best to use 2-3 moving averages for a fairly reliable signal. Using 1 moving average will give you fewer signals.
Points To Remember:
The long moving average gives you the trend.
The short MA gives you the confirmation of the signal.
Using three moving averages will give you a short term, medium term and long term signal.
TIP: Some traders use Fibonacci number in moving averages.
Take out any chart and look out for it yourself. If you find them then do let me know in the comments section
"The most important investment you can make is educating yourself."- Warren Buffett