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How to Use Moving Average in Trading?

  • Feb 26, 2024

A common technical indicator utilized by both novice and seasoned traders is the moving average. So, let’s discuss about moving average for intraday in detail.

What is the Moving Average?

In order to find and examine patterns, moving averages (MAs) are computations that use repeated averages made from subsets of a full data set. It is employed as a technical indicator in the DMA in stock market to map out potential future stock price moves. The 15-, 20-, 30-, 50-, 100-, and 200- averages are the most widely used moving averages. There are a plethora of additional technical indicators, including pivot points, stochastic oscillators, and the relative strength index.

Types of Moving Averages

There are basically two types of averages. They are: -

1.    Simple Moving Average (SMA)

The computation of the simple moving average involves summing up all closing prices over a predetermined number of periods and dividing the total by the number of periods. For instance, you would tally the closing prices for the previous ten days and divide the result by ten to get a 10-day SMA.

2.    Exponential Moving Average (EMA)

Though it provides greater weight to current prices, the exponential moving average is comparable to the simple moving average. This implies that in comparison to the SMA, the EMA will respond to price fluctuations more quickly. The EMA is calculated using a more complicated algorithm, but in essence, it considers all historical data points and assigns them a diminishing weight with increasing age.

How to Use Moving Average Indicator?

Being a lagging indicator, the moving average offers information about previous prices. The lag boosts with the length of the moving average period. Given that the former is displayed for the last 200 days, a 200-day MA (DMA) will lag significantly more than a 20-DMA. Since the latter is plotted using the most current 20-day data, it will lag far less.

An indicator that can be fully customized is the moving average. A moving average with any period duration is an option. Naturally, the MA is more susceptible to swings in price the shorter it is.

Things to keep in mind while using moving average: -

  • Traders deal with the short-term moving averages and the longer-period ones as well.
  • It is reasonable to do a trial of a couple of periods of the moving average before determining what suits you.
  • A trend in a security price upwards is illustrated by a rising moving average; it means a downward moving average, but it is a different story.

Why Use the Moving Average?

Moving averages are useful for a number of tasks in forecasting and data analysis. Some of the reasons are: -

  1. Data Smoothing: By mitigating data volatility, a moving average facilitates the identification of underlying trends or patterns.
  2. Noise reduction: It removes anomalies or random noise from the data so that analysts may concentrate on the important details.
  3. Finding Trends: Moving averages can be used to determine the direction of a trend, whether it is sideways, upward, or downward, by averaging data over a given time period.
  4. Forecasting: Moving averages are employed as forecasters of future values by focusing on the historical data trend to elicit projected outcomes.
  5. Signal Generation: In technical analysis, moving averages are commonly implemented to generate buying/selling signals when they cross over or under certain delimits.
  6. Data Visualization: Incorporating moving averages into charts or graphs is a great enhancement of data visualization as it simplifies the trend data for the stakeholders who can see them better.

Tips for Using Moving Averages

  1. Combine with Other Indicators: Moving averages, when coupled with varied other technical indicators such as support and resistance levels, trend lines, and volume trading, have the best working capacity.
  2. Consider the Time Frame: There will be different moving average lines as the time frame is different. Hence, it is important to consider which time frame is most relevant to the trading strategy.
  3. Keep It Simple: Utilizing more different moving averages on one chart may cause confusion and uncertainty. Stick to one or two at the most. This gives the best results.
  4. Watch for False Signals: Averaging moving can give a fake signal, especially in the volatile markets. Always keep in mind the fact that there are other factors and indicators, so rather consider them before making a decision to trade based on the moving average.

The Bottom Line

With the use of moving averages, traders may effectively discern patterns, levels of support and resistance, as well as possible points of entrance and exit. Your chances of making better selections and, eventually, your total trading success can be enhanced by knowing how they operate and incorporating them into your approach. Moving averages should, therefore, be taken into consideration in your analysis, regardless of your level of trading experience.

Team Sharekhan
by Team Sharekhan

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