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Moving Averages Tutorial

Moving Averages Tutorial



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Updated 09/06/2006
Moving Averages Tutorial
By Casey Murphy,ChartAdvisor.com
Thanks very much for downloading the printable version of this tutorial.
As always, we welcome any feedback or suggestions.
Table of Contents

1) Moving Averages: Introduction
2) Moving Averages: What Are They?
3) Moving Averages: How To Use Them?
4) Moving Averages: Factors To Consider
5) Moving Averages: Strategies
6) Moving Averages: Different Flavors
7) Moving Averages: Conclusion


Technical analysis has been around for decades and through the years, traders
have seen the invention of hundreds ofindic a tors. While some technical
indicators are more popular than others, few have proved to be as objective,
reliable and useful as the moving average.

Moving averages come in various forms, but their underlying purpose remains
the same: to help technical traders track thetrends of financial assets by
smoothing out the day-to-day price fluctuations, ornois e.

By identifying trends, moving averages allow traders to make those trends work
in their favor and increase the number of winning trades. We hope that by the
end of this tutorial you will have a clear understanding of why moving averages
are important, how they are calculated and how you can incorporate them into
your trading strategies.

What Are They?
Among the most popular technical indicators, moving averages are used to
(Page 1 of 18)
Copyright \u00a9 2006, Investopedia.com - All rights reserved.
Investopedia.com \u2013 the resource for investing and personal finance education.
This tutorial can be found at:http://www.investopedia.com/univers ity/movingaverages/default.asp

gauge the direction of the current trend. Every type of moving average
(commonly written in this tutorial as MA) is a mathematical result that is
calculated by averaging a number of past data points. Once determined, the
resulting average is then plotted onto a chart in order to allow traders to look at
smoothed data rather than focusing on the day-to-day price fluctuations that are
inherent in all financial markets.

The simplest form of a moving average, appropriately known as a simple moving
average (SMA), is calculated by taking the arithmetic mean of a given set of

values. For example, to calculate a basic 10-day moving average you would add
up the closing prices from the past 10 days and then divide the result by 10. In
Figure 1, the sum of the prices for the past 10 days (110) is divided by the
number of days (10) to arrive at the 10-day average. If a trader wishes to see a
50-day average instead, the same type of calculation would be made, but it
would include the prices over the past 50 days. The resulting average below (11)
takes into account the past 10 data points in order to give traders an idea of how
an asset is priced relative to the past 10 days.

Figure 1

Perhaps you're wondering why technical traders call this tool a "moving" average
and not just a regularmean? The answer is that as new values become
available, the oldest data points must be dropped from the set and new data
points must come in to replace them. Thus, the data set is constantly "moving" to
account for new data as it becomes available. This method of calculation ensures
that only the current information is being accounted for. In Figure 2, once the new
value of 5 is added to the set, the red box (representing the past 10 data points)
moves to the right and the last value of 15 is dropped from the calculation.
Because the relatively small value of 5 replaces the high value of 15, you would
expect to see the average of the data set decrease, which it does, in this case
from 11 to 10.

Figure 2
(Page 2 of 18)
Copyright \u00a9 2006, Investopedia.com - All rights reserved.
Investopedia.com \u2013 the resource for investing and personal finance education.
This tutorial can be found at:http://www.investopedia.com/univers ity/movingaverages/default.asp
What Do Moving Averages Look Like?

Once the values of the MA have been calculated, they are plotted onto a chart
and then connected to create a moving average line. These curving lines are
common on the charts of technical traders, but how they are used can vary
drastically (more on this later). As you can see in Figure 3, it is possible to add
more than one moving average to any chart by adjusting the number of time
periods used in the calculation. These curving lines may seem distracting or
confusing at first, but you'll grow accustomed to them as time goes on. The red
line is simply the average price over the past 50 days, while the blue line is the
average price over the past 100 days.

Figure 3

Now that you understand what a moving average is and what it looks like, we'll introduce a different type of moving average and examine how it differs from the previously mentioned simple moving average.

The simple moving average is extremely popular among traders, but like all technical indicators, it does have its critics. Many individuals argue that the usefulness of the SMA is limited because each point in the data series is

weighted the same, regardless of where it occurs in the sequence. Critics argue

that the most recent data is more significant than the older data and should have a greater influence on the final result. In response to this criticism, traders started to give more weight to recent data, which has since led to the invention of various types of new averages, the most popular of which is the exponential moving

average (EMA). (For further reading, see Basics Of Weighted Moving Averages
and What's the difference between an SMA and an EMA?)
Exponential Moving Average
The exponential moving average is a type of moving average that gives more
weight to recent prices in an attempt to make it more responsive to new
(Page 3 of 18)
Copyright \u00a9 2006, Investopedia.com - All rights reserved.

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