Moving Average In Stock Market: All You Need To Know | Espresso

Know Everything About Moving Average in Stock Market!

Every trader or investor in the market makes use of certain indicators or markers before conducting a transaction so that they can make gains on the transaction. They benefit by using the various tools of technical analysis and technical indicators that help them identify the movements and trends taking place in the market.

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One of the most important indicators used by many participants in the market is the moving average. In this article, we will understand all about the moving average and how to use a moving average to buy stocks.

What is Moving Average?

The moving average is one of the significant technical indicators that is calculated in the form of an average of a given set of data. In technical analysis, this data is the price points of the securities in the market, such as commodities and stocks. Thus, the moving average is calculated by totalling all the price points of a given security and dividing it by the number of price points in the data.

This average is called the moving average because the average tends to change when the data points, which is the price of the underlying security, keep changing as time passes. Therefore, when calculated for a specific period of time, like 10 minutes or one week, the moving average depicts the average price action value that the security underwent in that specific period of time.

Understanding Moving Average

In simple terms, moving average is a tool for technical analysis. The moving average is calculated according to the price value of a stock in the past. Therefore, a trader can use it as a useful indicator to understand the direction of the price in the future. It helps to identify the price action and helps traders recognise the price trend of a certain security.

If the moving average of security is showing an upward figure, this means that the price of the security has been rising. This showcases an upward trend, whereas if the moving average is showing a downward figure, then the price of the security is falling. This means it is a downward trend.

Also, as moving averages tend to follow historical price movements, they can help traders establish levels of support and resistance. Most traders make use of the moving average to understand if the price is bouncing back, going towards, or breaking the support and resistance levels that have been established.

The duration of the moving averages can be changed as per the requirements of a trader. For example, if you are a short-term trader, you can make use of a moving average that spans a period of 30 days, whereas if you are a long-term trader, you can use a moving average that spans 200 days.

Types of Moving Averages

Although the moving average is useful for almost every trader in the market, all traders do not use it in the same form. There are two major types of moving averages; these include:

  • Simple moving average

The commonly used form of moving average in technical analysis is a simple moving average. A simple moving average is calculated as a mean of the given data points, usually the price of a security and then dividing it by the number of values given. The calculation is done as follows:

(A1 + A2 + A3…..An)/n = Simple Moving Average

Here

A denotes the average within a specific period of time

N is the number of values

The most commonly used periods for SMA tracking are 8, 20, 50, 100, and 200 days.

  • Exponential moving average

The second type of moving average is called exponential moving average. This is a weighted moving average in which the recent values of price are given more weight in comparison to the price values of the past. To get to the right exponential moving average, a trader must calculate the SMA of the price values of the security first. The formula that is used gives less and less weightage to the average price values of each passing period. The formula is:

Exponential moving average = Closing price x multiplier + EMA (previous day) x (1-multiplier)

The exponential moving average tends to adapt faster and better to the changes in the price movements than the SMA.

Conclusion

Moving average is an effective and straightforward tool for technical analysis in the stock market. This helps traders identify market trends so that they can use these while trading. In addition, since moving averages take into account the price movements of the past, it helps traders know the future price direction of security before they make any transaction. However, just like any other tool for technical analysis in the market, the moving average should be used along with other tools to identify market opportunities in a better manner.

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Frequently Asked Questions

Some of the basic differences between a simple moving average and an exponential moving average are that SMA is slower when responding to the price movements, whereas EMA is faster. Moreover, SMA gives equal weight to each and every period, whereas EMA gives more weight to the recent ones. Also, SMA does not emphasise the actions of the traders, while EMA does emphasise what the traders are doing at the current moment.

One of the major disadvantages comes when the stock does not show an uptrend or downtrend; then, the future values of the stock cannot be predicted. So, traders will not be provided with an opportunity to gain by using moving averages. Moreover, the moving average does not take into consideration primary factors that can affect the price of a security.

Moving averages can be considered beneficial for the traders because:

  • Moving averages help a trader identify the trends in a market. Thus, a trader can make use of and understand most of the trends that have been established in the market.
  • It is also deemed to be advantageous as it helps to determine the potential price support.
  • It helps to measure the momentum. It helps a trader identify the strength and direction of the momentum of an asset.