Why moving averages are a must for trading model ?

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Written By WindowsHindi

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Stock or index analysis encompasses numerous methods to determine its price outlook. One of the simple techniques among the technical analysis is ‘Moving Average’.

Moving average is the average value of a security over a specified period of time. Usually, when the current price of the security is above its moving average, the trend is considered to be 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 known as ‘simple moving averages’. Combinations of these moving averages often indicate substantial movement in a stock price.

Intra-day traders consider lower averages, such as 9-DMA, 13-DMA, 20-DMA, as they help them capture profits on a day-to-day basis while helping them mitigate the risk.

From a broader perspective, the major moving average is 200-DMA. Securities trading above or crossing 200-DMA on monthly charts attract attention from long-term investors, resulting in a steady up trend thereafter.

Other than the DMAs or simple moving averages, another moving average technique that is used by traders and investors is ‘exponential moving averages’.

The difference between the two is that while simple moving averages give equal weightage to all the data points; exponential moving averages apply more weight to recent data.

Exponential moving average (EMA) considers the weighted average of a series of recent data to reflect the present trend in the market. The weight of EMA tilts towards recent occurrences

Thus, exponential moving averages facilitate trading when one is attempting to make swing profit as it reflects a change in move rather quickly.

A moving average is used by technical analysts to keep track of price trends for specific securities. An upward trend in a moving average might signify an upswing in the price or momentum of a security, while a downward trend would be seen as a sign of decline.

Now that we have clarity of the meaning and significance of moving averages, let’s understand how can you use the same while trading or making investment decision.

As can be seen in the chart, the crossover of moving averages is recognized as a trading signal. This reflects the change in sentiment which inevitably impacts the prices.

One of the cross over techniques of moving averages is the ‘golden cross’ pattern. Here, the smaller moving average crosses over the larger moving average.

As can be seen in this chart for Berger Paints, the 50-DMA has made a positive crossover with 200-DMA, which indicates a bullish outlook.

Likewise, a ‘death cross’ gives a negative outlook as and when the 200-DMA falls below the 50-DMA.

To conclude, moving averages can assist in filtering out unwanted ‘noise’ and provide a clear view on the underlying index or stock.

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