Moving average is one of the most used technical indicators in the stock market. MA is used to gauge the market trend in the stock market. MA is a mathematical calculation by averaging the past data points. Chartist otherwise calls the moving average as rolling means. Based on the calculation made the moving averages are again broadly classified into two which Simple Moving Average and Exponential MA.
Chartist when mention moving average invariable it should be considered as Simple Moving Average in short SMA.
Largely Technical Analysis is an Art. Every person looks at a chart in a different way. While two chartists can argue if a candlestick formation is a triangle or a wedge it completely depends on analysis. Such a scenario it’s tough for a computer to give clear buy and sell signals. For computer generated signals based on certain predetermined factors, clarity of interpretation is the key.
The clarity of signal from moving averages is very clear, unlike candlestick patterns. MA works on price action. It helps to smooth out the price actions, which in turns allows predicting the current price trends based on the chartist’s selection of time frame.
Moving average although being a very clear indicator because of the number of variables and options available the use of moving average differs from person to person. MA is very flexible to different time frames. MA can be independently used for trend analysis of the stock market and can be combined with other indicators also.
The application of moving average is not limited to the stock market but it can be applied to commodities, forex, gold, bonds, mutual funds, financial valuations, real estate, economic indicators, etc.
Secrets To Getting Moving Average To Predict in Stock Market Quickly
Technical analysis aka moving averages can also be used in Commodities. Gold and silver are one of the most popular commodities traded around the world. Find below the infographic on how moving average was used to predict prices of gold.
Simple Moving Average Calculation
MA can be calculated for any number of times series based on the data set available.
When it comes to our understanding about average is the sum of the total number of data set available by the total number of data set.
When it comes to moving average, with every new value-added the data set used for calculation includes the latest data value and excludes the first number included in the earlier calculation. With the below example one can easily understand the explanation.
In simple words, if someone wants to calculate the moving average of last ten days. One could add up the closing price of the last 10 days and then divide it by 10. One would arrive at Simple MA
Facts About Moving Average[Info-graphic]
Moving Average Formula
It is known as the price smoothing method because every time it takes an updated dataset. The MA Method uses an average of several data sets for the same duration. The result is continuous and smooth data set. A data set with less volatility or standard deviation increases the productivity of moving average.
With the above explanation and example if you are still finding it tough to understand. We have added an explanation of moving average in an excel sheet which can be used by you for reference.
Moving Average Excel
This example teaches you how to how to calculate moving averages in excel. For short duration and dataset excel can be used. When the dataset becomes very large and the duration reduces then one would need an automatic software which shows live data.
Simple Moving Average for Indian Stock Market Index Nifty AlphaTrading – Excel
Learn how to generate Trading Signals in Spreadsheet.
You have to first select the moving average period based on the dataset available to you. Once you have decided on the data set you can use the formula in the excel as given below:
This is the formula for 10 Day MA according to the excel attached. Next, you can simply drag the box or double-click on the square button on the and entire column would be auto-filled.
What does 200 DMA mean?
One of the vital indicators for trader and investor on the long trend is the 200-day moving average. At the macro level, the emphasis given on this moving average is very high. The 200-day moving average is considered as major support and resistance for the long-term trend. When the price level is above the 200-day moving average it would be called a resistance and when the 200-day moving average is below the price level that can be called as support.
If we take the 200-day moving average to the time when the dow was created and if we see the backtest results. It’s surprisingly outperformed the index returns on YOY basis.
There are different ways in which moving average can be put to use to generate consistent income. Large stock holding decision is based out this such a Hedge Fund and Mutual Fund companies.
Since the number of closing values taken is 200 which comes exactly 40 weeks in a year. One can determine a long trend which can be another year also.
Find below the 200-day Simple Moving Average on a candlestick chart.
The above is a daily chart of Nifty Index with 200 days moving average. If you notice when the price level stays above the red line which is otherwise the 200-day moving average we can conclude that the index is in a bullish trend. Likewise, when the stock price level is below the moving average of 200-days we can conclude that the index is in a bearish trend.
Backtesting of the strategy can always be done with various software available in the market.
What happens when the 50 day moving average crosses the 200-day moving average?
The reason why the 200-day moving average is considered so critical and a very important indicator is because when the 50-day SMA crossing to the downside of the 200-day SMA this crossover is called, “death cross”, signaling a serious bear market in the index, stock, commodity or another other investment. Likewise, when the 50-day SMA crossing to the upside of the 200-day SMA this crossover is called, “golden cross”, signaling a serious bullish market in the index, stock, commodity or another other investment.
Find the Info-graphic for using the moving average method in Forex to generate trading signals.
Research analyst, business news channels, business newspapers and other business media houses closely follow the 200 SMA and many decisions are taken strongly in relation to this. The other way round is also possible that market performs so strongly at those level that researcher and analyst give importance to these levels.
The Lagging Factor
A follower & not a Leader.
A trend following tool whose purpose is to identify that a new trend has started or the current trend has ended. It also shows us the current status of the trend is continuing or ending.
Stock Pattern and Candlestick pattern on the other hand predict the stock market beforehand which is not the case with moving averages. Moving average nature is not to anticipate rather it only reacts to the price.
MA is mostly treated as a smoothing device which makes the movements in the stock prices smooth and easy to understand. It tells if the trend has begun or not only after the event happens.
Since this is treated as a smoothing indicator a shorter simple moving average sticks very close to the price level when compared to the higher moving average. In the above example if you notice the 50-day SMA is very close to the price when compared to the 200-day SMA. With this one can understand that the lag time reduces with shorter time frames when compared to larger time frames.
Complete elimination of the lagging is not possible in Simple MA for the only reason it reacts and does not predicts.
An ineffective way to reduce the lagging is changing the price points selected for calculating a simple moving average from closing price to opening price. This is a futile effect to reduce the lagging effect in the stock market movement. At times certain chartist also uses the mid-price or average price of high and low to derive at the price for generating the moving average.
Weighted Moving Average
To resolve the lagging effect various other methods were used to reduce or eliminate the lagging effect.
Thus giving high importance to the latest closing price and least importance to the oldest closing price in the data set gave rise to the weighted moving average. This is done by giving a percentage value to the higher to the latest based on the number of a time period and the lowest to the oldest value.
The result of this is that the lagging effect of the 200-day moving average reduced drastically. If you see the image below you would find that the green line is the 50-day moving average, the blue line is the 200-day weighted moving average and finally, the red line is the 200-day simple moving average.
The weighted moving average resulted in another set of limitations which did not exist earlier. This led to another moving average exponential moving average.
Exponential Moving Average
According to Investopedia, “EMAs, sometimes called exponentially weighted moving averages, are also weighted towards the most recent prices, but the rate of decrease between the one price and its preceding price is not consistent. The difference in decrease is exponential”.
The backline in the below chart is 200-days exponential moving average.
Lengths and Timeframes
The candlestick range from 1min to 1month when the moving average is placed on top of it. Based on the need of the study one should select the charting candle time frame.
Generally, the most popular moving average are 200-day, 50-day, and 20-day. This is completely open to modification for different underlying. Certain chartist use 7-day, 14-day and 28-day moving average.
One of the most common questions asked is what is the best length for moving average. There is no one answer to this question. Every moving average performs differently during different situations. There is no holy grail moving average system which works all the time. What one has to look for is which moving average performs consistently for a stock.
Likewise, there is no one time period of the candlestick that gives superior results. Most of the charting software consists of candlestick period of 1min, 2min, 5min, 10min, 15min, 20min, 30min, 60min, 1day, 1week, and 1month.
The right combination of the above is very crucial for a chartist or a stock trader.
Keeping this disadvantage in mind gave rise to using multiple crossovers. In case of crossover, one gives the signal another moving average gives a confirmation. This removes the disadvantage of the single moving average to a very large extent.
Double Crossovers/Triple Crossover
MA crossover strategy is one of the easiest strategies to understand. All the charting software would have this essential charting tool.
MA crossover in simple terms is when the shorter moving average crosses the bigger moving average it results in a crossover. To decide the trend of the crossover it is very important that one understand which side the crossover is happening. If the shorter moving average crosses the larger moving average from above then it is a start of a bearish trend.
Likewise, if the shorter moving average crosses the larger moving average from the below then it is a start of a bullish trend.
The shortcoming of the double crossover moving average is that at times it gives a false alarm or false signal which results in trading and investing losses which arise out of usually shorter trading durations.
This gave rise to the triple crossover which consists of two shorter moving average and one longer moving average, for example, 20-day, 50-day, and 200-day moving average. In this case, everything is similar to the double crossover expect that it requires two short duration moving average to crossover one larger moving average to initiate the trade.
All the while focus has been to always get the signal with greater accuracy and confirmation. Invariably failed to notice that the lagging effect remains across all the charting methods.
Every strategy right from moving average, double crossover and triple crossover the lagging effect still remains. This gave rise to moving average envelope and price level crossover.
Price Level crossover is when the closing price of the candlestick crosses the predetermined moving average this generates the buy or sell signal. When the candlestick’s closing price closes above the moving average it is a start of a bullish trend. Similarly, if the candlestick’s closing price closes below the moving average it is a start of a bearish trend.