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Section: 3 Market Structure
Sub Section: 3 Moving Averages
The moving average of a stock index is the average level of the index over a given interval of time. For example, a 52-week moving average tracks the average index value over the most recent 52 weeks. Each week, the moving average is re-computed by dropping the oldest observation and adding the latest. After a period in which prices have generally been falling, the moving average will be above the current price (because the moving average “average in” the older and higher prices). When prices have been rising, the moving average will be below the current price. When the market price breaks through the moving average line from below, it is taken as a bullish signal because it signals a shift from a falling trend (with prices below the moving average) to a rising trend (with prices above the moving average). Conversely, when prices fall below the moving average, it’s considered time to sell. There is some variation in the length of the moving average considered most predictive of market movements. Two popular measures are 200-day and 52-week moving averages. The longer the time span, the less sensitive the moving average will be to daily price changes. Moving averages are used to emphasize the direction of a trend and smooth out price and volume fluctuations (or "noise") that can confuse interpretation.
a) Simple Moving Average:A Simple Moving Average is an average of data calculated over a period of time. The moving average is the most popular price indicator used in technical analyses, and can be used with any price (e.g. Hi, Low, Open and Close) or it can be applied to other indicators. A moving average smoothes a data series, which is very important in a volatile market. Also, trends are easier to spot using a moving average. An example is illustrated graphically as follows:
b) Exponential Moving Average (EMA): An Exponential Moving Average is an average of data calculated over a period of time where the most recent days have more weight. The exponential moving average can be used with any price: Hi, Low, Open and Close or it could be applied to other indicators. An Exponential Moving average smoothes a data series, which is very important in a volatile market. In order to reduce the lag in simple moving averages, technicians often use exponential moving averages (also called exponentially weighted moving averages). An example is illustrated graphically as follows:
c) Triangular Moving Average: A Triangular Moving Average is an average of data calculated over a period of time where the majority of the weight is placed on the middle portion of the price series. They are actually double-smoothed simple moving averages. The Triangular Moving Average can be used with any price (Hi, Low, Open, Close) or it can be applied to other indicators. The Triangular Moving Average smoothes a data series, which is very important in a volatile market.
d) Weighted Moving Average: A Weighted Moving Average is an average of data calculated over a period of time, where greater weight is attached to the most recent data.The Weighted Moving Average can be used with any price (Hi, Low, Open, Close) or it can be applied to other indicators. The Weighted Moving Average smoothes a data series, which is important in a volatile market. Weighting is calculated from a sum of days.
A weighted moving average is calculated by multiplying each of the previous day's data by a weight. The weight is based on the number of days in the moving average. For example for 5-day weighted moving average, the weight on the first day is 1.0 while the value on the most recent day is 5.0. This gives five times more weight to today's price than the price five days ago.
Moving averages can be effective tools to identify and confirm trend, identify support and resistance levels, and develop trading systems. The most popular method of interpreting a moving average is to compare the relationship between moving averages of the security's price with the security's price itself. A buy signal is generated when the security's price rises above its moving average and a sell signal is generated when the security's price falls below its moving average.