What Price?
Those are the groups of families of moving averages that you have on most charting software. Just before going on to show you how you use them, I must mention that some traders also get concerned with which price is used in the moving average calculations.
With many charting packages, you’ll just have a choice of type of moving average and number of time periods. Universally, by default the price for each day is the closing price, so that standard is what I use in this module.
There are some analysts who prefer to use the mid-range value of the trading during the day, which is summing the high and low values and dividing by two. Some others will add the high, low, and closing prices together and divide by three to get the price for the day. And others will calculate moving averages for the high prices and low prices separately and draw two lines, which means the difference between them gives some indication of the market volatility.
None of these variations has had much impact in the trading world – don’t you think they’d be more prominent in common trading software if they were dramatically better? – but you might as well know about them in case they crop up in the future.
How to Use Them
There are many different ways to use moving averages in technical analysis. I’ll go through the main ones here, but other ways are being invented all the time. Because of volatility, prices go up and down and individually provide little meaning. Moving averages provide a way to smooth out these wild undulations and isolate the overall movement of prices.
All moving averages fluctuate less than the prices. The greater number of days you average, the gentler the moving average but also the more the value lags current price action. So selection of the number of days is important and depends what you’re trying to achieve with the average.
You can always experiment with increasing or decreasing the number of days, and different values may work better in different markets. The selection is critical, but with hindsight you could always find the moving average which would have been most profitable – the challenge is to find the moving average which will be consistently profitable in the future.
Note also that moving averages tend to work better for certain markets than others so experimentation and backtesting helps here. It is also important to bear in mind they are of little use in a sideways market where they tend to give plenty of false signals.
Join the discussion