Using Moving Averages

A Moving Average is the average of a market's closing prices over a defined period of time. For example, a 20-day moving average is an average of closing prices over a 20-day period. As price activity on a chart moves forward each day, the last day is dropped (day 21) and the latest closing price is added.

Moving averages will not indicate an imminent trend change, but will help you determine if an existing trend is continuing by measuring the direction, or help to confirm that a trend reversal has taken place. A moving average is similar to a trendline except that the moving average curves with the movement of price. It can also provide support and resistance levels.

The advantage of using moving averages is the ability to apply 2- or 3-line moving averages on the same chart. Each average is for a different period of time, for example, a 9-day average and an 18-day average. Most commonly the shorter day (or bar) average is referred to as a fast moving average, and the longer day (or bar) moving average is referred to as a slow moving average. Doing this can provide you with buy and sell signals when one line crosses over the other line.

In addition to the simple moving average, or a 2- or 3-line moving average, you can also apply a weighted moving average. This assigns more value to recent price data and lesser value to prices further back in time.

The trend is considered to be up as long as the moving average line is rising along with the price. A close below could indicate a change in direction. A downtrend is considered to be continuing as long as the line is declining along with the price. A close above could indicate a change in direction.

The length of time you should use for your average depends on whether you are tracking a near-term, intermediate or long-term trend. You can also apply other indicators, such as Bollinger Bands, around a moving average to monitor support and resistance levels as well as determine market extremes.