Moving averages provide an objective measure of trend direction by smoothing the price data. Normally calculated using closing prices, moving averages can also be used on median, typical and weighted closing prices as well as other indicators (see Indicator Smoothing).
Shorter length moving averages (MA's for short) are more sensitive and identify new trends earlier, but also give more false alarms. Longer moving averages are more reliable but only pick up the big trends.
It is best to use a moving average that is half the length of the cycle that you are tracking. If the peak-to-peak cycle length is roughly 30 days then a 15 day MA is appropriate. If 20 days, then a 10 day MA is appropriate. You will, however, often find traders using 14 and 9 day MA's for the above cycles in the hope that they will generate signals slightly ahead of the market.
Cycles vary in length over time - always check that the moving average you are using is still appropriate.
Click on the following links for details of the various moving average trading systems:
Single Moving Average
Compares price to a single moving average. The system is often used with
filters.
Filters
Filters are used to eliminate uncertain signals by objectively measuring
when price has crossed the moving average.
Moving Average Directional Filter
Uses the slope of the moving average as a filter.
Two Moving Averages
Uses a fast moving average instead of a filter.
Three Moving Averages
The third moving average identifies when price is ranging.
Multiple Moving Averages
A series of five fast moving averages and five slow moving averages.
The simple moving average (or SMA) is the easiest to construct. A 5 day SMA takes the sum of the last 5 days prices and divides by 5. Easy but not always accurate: the indicator has a tendency to "bark twice". Consider this example:
|
Day |
1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 |
|
Price ($) |
16 | 17 | 17 | 10 | 17 | 18 | 17 | 17 | 17 |
|
5 Day SMA |
15.4 | 15.8 | 15.8 | 15.8 | 17.2 |
You can see that on day 9 there is a big step in the simple moving average, but price has been constant at $17. This distortion is caused by the low price on day 4 - dropped from the SMA on day 9.
To calculate an exponential moving average (EMA):
If we recalculate the earlier table we see that the exponential moving average presents a far smoother trend:
|
Day |
1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 |
|
Price ($) |
16 | 17 | 17 | 10 | 17 | 18 | 17 | 17 | 17 |
|
33.3% (or 1/3) EMA |
16.7 | 14.4 | 15.3 | 16.2 | 16.5 | 16.6 | 16.8 |
EMA% is the weighting attached to the current days value:
How to calculate an EMA% for a selected time period (the indicator panel performs this calculation automatically):
EMA% = 2/(n + 1) where n is the number of days
Example: The EMA% for 5 days is 2/(5 days +1) = 33.3%
A Weighted moving average (WMA) attaches greater weight to the most recent data. The weighting is calculated from the sum of days.
Example: For a 5-day weighted moving average the Sum of Days is 1+2+3+4+5 =
15
The weighting is shown below:
|
Day |
1 | 2 | 3 | 4 | 5 |
|
Price ($) |
16 | 17 | 17 | 10 | 17 |
|
Weighting |
1/15 | 2/15 | 3/15 | 4/15 | 5/15 |
|
Weighted value |
1.07 | 2.27 | 3.40 | 2.67 | 5.67 |
|
5 Day WMA |
15.07 |
Weighted values are calculated by multiplying today's price by 5/15, yesterday by 4/15, and so on. The weighted moving average is the sum of the 5 weighted values.
Indicator Panel shows how to set up moving averages.
The default setting is a 21 day exponential moving average. Edit Indicator Settings explains how to alter the default settings.
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Moving Averages
Moving Averages - Part 2 -- Chart School
Moving Averages - Part 1 -- Chart School
Introduction, Moving Averages - Technical Analysis from A to Z
Moving
Averages - Technical Analysis from A to Z