Welcome to the Investors Trading Academy talking glossary of financial terms and events.
Our word of the day is “Moving Average”.
A moving average is one of the most flexible as well as most-commonly used technical analysis indicators. It is highly popular among traders, mostly because of its simplicity. It works best in a trending environment.
In statistics, a moving average is simply a mean of a certain set of data. In case of technical analysis, these data are in most cases represented by closing prices of stocks for the particular days. However, some traders also use separate averages for daily minima and maxima or even an average of midpoint values (which they compute by summing up daily minimum and maximum and dividing by it two). Yet, you can construct a moving average also on a shorter time-frame, for example by using daily- or minute- data.
For example, if you want to make a 10-day moving average, you just add up all the closing prices during the last 10 days and then divide it by 10 in this case it is a simple moving average. The next day we do the same, except that we again take the prices for the last 10 days, which means that the price that was the last in our computation for the previous day is no longer included in today's average - it is replaced by yesterday's price. The data shift in this manner with every new trading day, hence the term "moving average".
Moving average is a trend-following indicator. Its purpose is to detect the start of a trend, follow its progress, as well as to report its reversal if it occurs. As opposed to charting, moving averages do not anticipate the start or the end of a trend. They only confirm it, but only sometime after the actual reversal occurs. It stems from their very construction, as these indicators are based solely on historical data. The fewer days a moving average contains, the sooner it can detect a trend's reversal. It is because of the amount of historical data, which strongly influences the average. A 20-day moving average generates the signal of a trend reversal sooner than the 50-day average. However, it is also true that the fewer days we use in the moving average's computation, the more false signals we get. Hence, most of the traders use a combination of several moving averages, which all have to yield a signal simultaneously, before a trader opens his position in the market. Nonetheless, a moving average's lag behind the trend cannot be completely eliminated.

By Barry Norman, Investors Trading Academy

свернуть