Moving Average – The Basics

A moving average is an indicator used in technical analysis that shows the average value of a security’s price over a set period of time. The purpose of this average is to track the trends of a security by smoothing out daily price fluctuations or “noise” that can confuse interpretation of the financial markets. Trend lines can move upward, downward, horizontal, or sideways. Through using this average the trader is able to identify trends in order to increase the number of winning trades. Traders do this through a calculation involving a number of past data points. Once this calculation is determined, the average is plotted on a chart. Traders then use this calculation rather than focusing their attention to price fluctuations occurring in the markets. These are available in all major charting software programs.

There are many ways that the moving average is used. The most widely recognized use is in identifying support and resistance levels.  Every stock has a price level in which is doesn’t typically fall below. Stock support levels are confirmed when a stock does not fall below its historical support level, and a stock’s support level is violated if the stock does fall below its historical price level. The basic explanation surrounding support levels is that the dropping price of an asset often stops and reverses in direction at the same level as an important average. In other words, the support level is the level at which most buyers typically enter the stock, and if it reverses at the support level, that support level is confirmed. The moving average is also used to detect resistance levels. The resistance level is the price in which a stock can trade, but cannot surpass for a set amount of time. Typically investors cannot push the price above that resistance barrier because the sellers begin to outnumber the buyers. Traders take this as a sign that they better close out their positions and take their profits. The ‘money makers’ also pay attention to moving average and through their large buy and sell orders  they often force the price movement, sending prices even further out. An important note; it is more difficult for prices to break above a declining moving average than a rising one, and equally as difficult for prices to move below a rising moving average.  Follow along in my ‘Market View’ category to begin to understand and get a visual depiction of moving averages in action.

We will go into greater detail on the different types and uses for moving averages in future articles posted in our Technical Analysis section. Combining them with Japanese Candlesticks will place greater probabilities to be in profitable trades. Review the weekly entries identifying candlestick chart patterns that are utilized when conducting candlestick analysis. Learn about the doji candlestick chart, the hanging man candle, and the dark cloud cover as well as what each pattern indicates is happening in the markets. Additionally you can read about the bullish harami candle and bullish engulfing pattern. A new candlestick signal is added each week!

Please also continue to learn how to incorporate Japanese candlesticks into your technical analysis methods so that you are on your way to successful investing!

Continue your technical analysis education and read now about the different types of moving averages.