Moving Averages in Technical Analysis

Moving averages (MA) are techncial indicators that illustrate the average price of a stock (or other security) over a defined period of time. As the stock’s price changes over that time period, its average price adjusts accordingly. Moving averages are one of the most popular tools available to the technical analyst, offering a way to track stock price trends in an effort to determine the likely future direction of that stock price.

What They Can Tell You

When looking at moving averages, you might observe one of three trends as the stock price may be trending up, down or trading within a range. An uptrend is observed when the price demonstrates both higher highs and higher lows. A downtrend would indicate the opposite. The stock is in a trading range if neither an uptrend nor downtrend is established.

Moving averages are also used to identify support and resistance levels with the understanding that the stock price tends to stop and reverse direction at these price levels. Technical analysts look for these trading boundaries to be broken (crossovers) to predict the future direction of the stock price.

Various Methods to Calculate

The different types of moving averages vary in how they are calculated, but the interpretation of each is the same.

Simple Moving Average (SMA) - The most common method used, it simply takes the sum of all of the past closing prices over a specified time period and divides that sum by the number of prices for that time period.

Exponential Moving Average (EMA) - Places a higher weight on recent data points, making it more responsive to more recent trends in the stock price.

Linear Weighted Average- The least common approach, it is calculated by taking the sum of all the closing prices for the specified time period and multiplying them by the position of the data point. That sum is then divided by total of the number of periods.

Time Periods Used

A moving average can represent any number of time periods ranging from “very short-term” (e.g. 5 days) to “long-term” (e.g. 200 days). While any time period can be used, may technical traders track the 50 and 200 day averages to understand the intermediate and long-term stock trend.

Looking at 50 and 200 day moving averages

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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