What is a Moving Average?
In simple words, the name is self-explanatory. Moving Average: An average, which is moving. So as the data is added, the average also moves and adjusts itself to the data. Simple enough?
There are various types of Moving Averages, Few are:
- Simple Moving Average (SMA)
- Exponential Moving Average (EMA)
- Weighted Moving Average (WMA)
Today’s topic is Simple Moving Average (SMA), I would try to explain as simply as I can :D.
Simple Moving Average
A simple moving average is made by adding the closer together, For however many days you want to be in the moving average, and then dividing by that number of days. So for a 5 day moving average you would add up the last 5 closes, and then divide by 5 to give you today’s moving average number.
Each day moving average number is plotted and forms a moving average line on the chart. Other Moving Averages, There are also other ways to calculate a moving average by giving the most recent close more importance and those are called exponential and weighted moving averages, which we will look at later, but for now let’s just stick with simple moving averages.
Reasons to Use Moving Averages
1 – Smooths out price data
If a market is moving in a choppy manner a moving average will help you to see the trend.
2 – Helps you tell market strength
Above a moving average can be considered bullish, below a moving average can be considered bearish.
3 – More than one moving average
You can put 2 moving averages on the chart and use the crossover of the moving averages as buy and sell signals or to tell trend.
The 200-day moving average is the moving average, most used to tell a bull from a bear market.
Generally speaking, if a market is trading above the 200 days moving average it is in a bull market.
If a market is trading below the 200 days moving average it is in a bear market.
Likewise, 100, 50, 20-day moving averages are usually used. How many days moving average is best or must vary from trader to trader as per his own trading style and research. There is no hard and fast rule to use a particular average.
In coming posts, we will see a Trading system based on Simple Moving Averages.