Technical Analysis: The Moving Average

Submitted by Stock Market News on 16 May, 2011 - 13:12

What is a moving average?

The moving average is another component associated with Technical Analysis. It is a common tool known by most investors and traders. In simple terms it is the average of the closing prices for the last 'n' days. The 'n' equals the number of periods. Therefore if you have a 30 day moving average, it represents the average of the of all closing prices in the last 30 days, which are then rolled forward one day a time.

By adding up the total of the closing prices for an 'n' period, and then dividing the sum by 'n', gives you a price chart that you can plot as a line. This will illustrate the moving average which provides the trader an indicator when to buy and sell.

The first thing that you have to do be able to plot your moving average is decide the ''n'', which is the period of time you want to cover. The larger the number, the smoother the moving average line will be. You will also have fewer trades and false signals. However, shorter moving averages will often get you into a trade earlier and exit closer to the top. You will also have a lot of false signals leading to losing trades.

The common way to trade is to buy if a stock price soars above its moving average and sell when the price plummets below it. A moving average is a good indicator for an uptrend. It can also help you get out of the market when there is a downtrend. In case of a non-trending market, the moving average will always have you losing money.

Although a moving average sounds like an easy and convenient you must always remember that it only works in a trending market. If there is a sideways market, the moving average will go through the middle of the prices. This will force you to buy high and sell low, which will make you lose money every single time.