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Simple Moving Averages - The Basics (and Benefits) of Simple Moving Averages
By : Ian C Jackson
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In spite of some people tending to write them off, moving averages are probably the most common type of indicator and they are widely used as a prime or base indicator by almost every trader. Because nearly all trading is based upon a trend in one way, shape or form, the characteristics of the MA as it is known, offer the ideal platform from which to make an initial judgement and then build up a couple more complementary indicators.
If we look at almost any graph of prices we usually see something less than a smooth consistent curve of fluctuating prices, it is more often than not at least a bit choppy.
We use moving averages to smooth out this price range into a more much more manageable curve and to risk stating the obvious, the MA curve is produced thus; the average of closing prices over, for instance, twenty days is calculated by adding all the closing prices over a continuous and previous twenty day period and dividing the sum by 20. For each following day, take the previous twenty days and then keep repeating the process.
Instead of using daily closing prices, you may wish to calculate over another increment, depending upon your strategy, your chart and whatever it may be that you are trading. Forex traders or scalpers may choose closing prices for each minute, five minutes fifteen minutes for instance. The principle is the same.
The longer the time frame you use, the more discreet and smooth the moving average line will be. Popular time frames are over 5, 9, 20, 40, 50, 100 and 200 days. Ultimately depends upon your preference.
Whether or not you have charting software, it is easy to do a spot of experimenting and try a few set ups for yourself. You should bear in mind that the tighter the MA, the less smooth the curve, since the MA will become closer to actual price.
Once you have tied a few moving averages over some different stocks you will see that different moving averages lend themselves to various stocks. A possible exception to this is sometimes the fifty day MA which can often be a good indicator of an underlying trend for quite a range of stocks.
When you have tried a few moving averages you will see that it is an easy to use and understand indicator, a simple line that reveals so much. Sometimes I use two together, say a 50 and 20, in different colours for clarity and I've met some traders who have been successful with three or four, but that is too busy for me. Their converging and diverging characteristics signal possible trading entry and exit points.
About the author:
Would you like discover more about the systems successful traders use to make profitable trades? Download them free here: Trading LessonsIan Jackson is well read in the online trading business, learning how to trade the hard way - and now he reveals how you can learn the business too, without all the growing pains.
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