Stock or index analysis encompasses many methods to determine its price outlook. One of the simple techniques among technical analysis is “moving average”.
The moving average is the average value of a security over a given period. Usually, when the current price of the security is above its moving average, the trend is considered bullish. Similarly, when the price falls below the average, the sentiment is said to be bearish.
The most effective moving averages are the 50-day moving average, or 50-DMA; 100-DMA and 200-DMA.
These are also called “simple moving averages”. Combinations of these moving averages often indicate substantial movement in a stock’s price.
Intraday traders consider lower averages, such as 9-DMA, 13-DMA, 20-DMA, as they help them capture overnight profits while helping them mitigate risk.
From a broader perspective, the main moving average is 200-DMA. Securities trading above or above 200-DMA on the monthly charts attract the attention of long-term investors, resulting in a steady upward trend thereafter.
Besides DMAs or Simple Moving Averages, another moving average technique used by traders and investors is “Exponential Moving Averages”.
The difference between the two is that simple moving averages give equal weight to all data points; exponential moving averages apply more weight to recent data.
The exponential moving average (EMA) considers the weighted average of a series of recent data to reflect the current market trend. The weight of the EMA leans towards recent events
Thus, exponential moving averages make it easier to trade when trying to make a swing profit because they reflect a change in movement quite quickly.
A moving average is used by technical analysts to follow the price trends of specific securities. An uptrend of a moving average could signify an increase in a security’s price or momentum, while a downtrend would be seen as a sign of decline.
Now that we have clarified the meaning and importance of moving averages, let’s understand how you can use them while trading or making an investment decision.
As can be seen from the chart, the crossing of the moving averages is recognized as a trading signal. This reflects the shift in sentiment that inevitably impacts prices.
One of the moving average crossover techniques is the “golden cross” pattern. Here, the smaller moving average crosses the larger moving average.
As seen in this chart for Berger Paints, the 50-DMA made a positive cross with the 200-DMA, indicating a bullish outlook.
Similarly, a “death cross” gives a negative outlook as the 200-DMA falls below the 50-DMA.
In conclusion, moving averages can help filter out unwanted “noise” and provide a clear view of the underlying index or stock.