Moving Averages (all methods)

Description

A moving average is a method of calculating the average value of a security's price, or indicator, over a period of time. The term "moving" implies, and rightly so, that the average changes or moves. When calculating a moving average, a mathematical analysis of the security's average value over a predetermined time period is made. As the security's price changes over time, its average price moves up or down.

MetaStock Pro calculates and displays six different types of moving averages: simple (also referred to as arithmetic), exponential, time series, triangular, variable, and weighted.  In addition, MetaStock Pro will calculate moving averages of the security's open, high, low, close, median price, typical price, volume, open interest, or indicator.

The only significant difference between the various types of moving averages is the weight assigned to the most recent data. Once this "weighting" scheme has been determined, it is held static over the range of calculations. The exceptions are the variable moving average and volume adjusted moving average. The variable moving average automatically adjusts its weighting based on market conditions. A variable moving average becomes more sensitive to recent data as volatility increases and less sensitive to recent data as volatility decreases.  Similarly, the volume adjusted moving average automatically adjusts as the security's volume increases and decreases.

Moving Average Calculation Methods

• Exponential
• Simple
• Time Series
• Triangular
• Variable
• Volume Adjusted
• Weighted

Interpretation

The most popular method of interpreting a moving average is to compare the relationship between a moving average of the security's closing price and the security's closing price itself. A sell signal is generated when the security's price falls below its moving average and a buy signal is generated when the security's price rises above its moving average.

This type of moving average trading system is not intended to get you in at the exact bottom and out at the exact top. Rather, it is designed to keep you in line with the security's price trend by buying shortly after the security's price bottoms and selling shortly after it tops.

The critical element in a moving average is the number of time periods used in calculating the average. When using hindsight, you can always find a moving average that would have been profitable. The key is to find a moving average that will be consistently profitable. The most popular moving average is the 39-week (or 200-day) moving average. This moving average has a good track record in timing the major (long- term) market cycles. The length of a moving average should fit the market cycle you wish to follow:

You can convert a daily moving average quantity into a weekly moving average quantity by dividing the number of days by 5 (e.g., a 200-day moving average is almost identical to a 40-week moving average). To convert a daily moving average quantity into a monthly quantity, divide the number of days by 21 (e.g., a 200-day moving average is very similar to a 9-month moving average).

MetaStock Pro enables you to plot moving averages of securities and any of the indicators tracked by the program. The interpretation of an indicator's moving average is similar to the interpretation of a security's moving average: when the indicator rises above its moving average, it signifies a continued upward movement by the indicator; when the indicator falls below its moving average, it signifies a continued downward movement by the indicator.

Indicators which are especially well-suited for use with moving average penetration systems include the MACD, Price R.O.C., Momentum, and Stochastics.

Some indicators, such as short-term Stochastics, fluctuate so erratically that it is difficult to tell what their trend really is. By removing the indicator (i.e., setting the Indicator Style to Invisible in the Indicator's Properties dialog) and then plotting a moving average of the indicator, we can see the general trend of the indicator rather than its day-to-day fluctuations.

Whipsaws can be reduced, at the expense of a slightly later signal, by plotting a short-term moving average (e.g., 2-10 day) of oscillating indicators such as the 12-day R.O.C., Stochastics, or the RSI. For example, rather than selling when the Stochastic Oscillator falls below 80, you might sell only when a 5-period moving average of the Stochastic Oscillator falls below 80.