One of the most widely known indicators used in a technical analysis is the Moving Average (MA). It is also one easy way to pinpoint the direction of a trend in a bigger perspective which makes it easier for the traders to spot stock opportunities. It uses a plotted line that shows and measures an average price helps determine if the trend of the stock is signaling a buy or a sell.
Although a Moving Average’s purpose is to identify trends and reversals, it is also used to describe the strength of the asset and point out positions of an asset that will touch either the support or resistance. Summing it all up, moving averages help give the traders an idea to what the direction of the future prices might be.
There are two major types of moving averages: the Simple Moving Average and the Exponential Moving Average. These two major types are the most commonly used ones with one of their most commonly used purposes is to determine price direction and the ability of a position to reach support and resistance lines.
There is also the Weighted Moving Average (WMA) which is similar to the simple moving average in terms of calculation which is used by analysts when they encounter some issues with the simple moving average’s time frame or in instances where the opening or closing price or the price action will not suffice them enough information regarding putting out buy or sell signals.
Comparing Simple, Weighted, and Exponential Moving Averages
While the main purpose of moving averages is to measure the price direction in aid of technical analysis in different markets or securities, moving averages also help show clearer and straighter price trends making the trends more reliable.
The simplest and most basic type of moving averages indicator is the simple moving average. It is probably the most used type of moving average following a formula that responds to the latest data in the computation of the average through adding prices and periods then dividing them by the number of data points while the Weighted Moving Average is calculated in the same way except it is used in addressing equal weighting issues. The WMA also uses a specific weighting factor according to how old they are with every value in the series of data. The latest data then will be given the biggest weight while smaller weight value will be given to price values while the SMA does not use any weighing factors to its data.
The Exponential Moving Average (EMA) like the WMA uses a weighing factor that aims to assign each value a certain weighting factor according to how recent or old the value is in a data series.
Use of Moving Averages
The primary reason why most traders and technical analysts use moving averages is to basically find trends and reversals and to show the support and resistance lines. This will allow one to easily figure out whether a certain stock or security is on an upward or downward trend and to where the moving average is going.
The advantage is using the indicator is that it is widely known and used in technical analysis of stock markets and other securities for the way it can smooth price data and show trends that can be easily used as a clear and simple chart that can be easily understood.
One must also keep in mind that the moving averages must also be used with other trading indicators which will add strength to either buy or sell signals. A strong knowledge built on grounds of experience will also ensure a higher success rate in using moving averages along with other tools that will build your strategy in trading. There is not one indicator without risk; this is why it is also important to understand all its functions especially in choosing the markets one will use with specific indicators.