Moving averages indicator
Averages
If you believe in the
"trend-in-your-friend" tenet of technical analysis, moving averages
are very helpful. Moving averages tell the average price in a given point of
time over a defined period of time. They are called moving because they reflect
the latest average, while adhering to the same time measure.
A weakness of moving
averages is that they lag the market, so they do not necessarily signal a
change in trends. To address this issue, using a shorter period, such as 5 or
10 day moving average, would be more reflective of the recent price action than
the 40 or 200-day moving averages.
Alternatively, moving
averages may be used by combining two averages of distinct time- frames.
Whether using 5 and 20-day MA, or 40 and 200-day MA, buy signals are usually
detected when the shorter-term average crosses above the longer-term average.
Conversely, sell signals are suggested when the shorter average falls below the
longer one.
There are three kind of
mathematically distinct moving averages: Simple MA; Linearly Weighted MA; and
Exponentially Smoothed. The latter choice is the preferred one because it
assigns greater weight for the most recent data, and considers data in the
entire life of the instrument.