Moving Average Technical Analysis

By: Dean Schuiteman
I have designed over a dozen analytical stock market software systems for other customers. These individuals generally come from a strong trading background and most often were senior analysts or advisors at a major financial firm. These people have often spent their lifetime studying the markets as well as analytical systems and theories concerning market trends. In almost all cases the systems these individuals want to build is based on the moving average. Time and again I have seen people test theory after theory only to return to using moving averages as their primary analytical tool.

The moving average is not as glamorous as many of the new indicators and specialized indices that mathematicians around the globe are clamoring to create however the moving average you can be sure is still one of the most important indicators you can use. After all, isn’t past performance the best indicator of future success?

Before we delve too far into an argument supporting the use of the moving average a bit of discussion regarding a description of how the indicator works is necessary.

A moving average is simply that, an average of the price of a stock over a set period of time. The benefit of using an average of the prices rather than the actual prices is the smoothing factor the average calculation incorporates into the result. By averaging the prices the impression of unusual price spikes or sudden drops are diminished and what emerges is a more stable or less volatile trend of a stock price’s history.

The smoothing benefit of the average has more of an impact over longer periods of time as should be expected. The more data points that are averaged then the greater the weight of the most common price trends. So longer period averages a popular one being 200 days for instance tend to result in much smoother lines than shorter averages. In a sense the longer term averages can be seen as representing a company’s long term potential, based on their historical performance and short term averages their daily or weekly trends.

The study of comparing short term moving averages against long term moving averages is probably the most common approach to using the moving average indicator. In fact one of the most popular traditional indicators the MACD (Moving Average Convergence/Divergence) is based on comparisons of short term versus long term moving averages. There are some distinctions between the calculation of the MACD and comparing short term versus long term moving averages however the principle is essentially the same. The difficult part is interpreting what the averages tell you about the stock’s performance. Essentially the question is always: Does a short term average cross over a long term line signal a new break out for the stock or will the short term trend fall back in line with the longer term trend? It’s not fool proof, you still have to make your own assessments, but the indicator can help you.

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