What are Moving Averages?
Moving Average (MA) is a trend-following or lagging indicator based on past prices and determine the presence, direction and changes in a trend.
There are two types of Moving Averages, faster Moving Averages and slower Moving Averages
- A faster moving average , is a short term moving average usually composed of 5, 10 or 25 day period. Short term moving averages identify new trends earlier but are not reliable by its own and in most cases give false signals.
- A slower moving average, is a medium or long term moving average composed of 50, 100 or 200 day period. Longer moving averages are more reliable in determining a trend.
Using Moving Averages
To determine a change in trend using Moving Averages it is necessary to plot at least a short and long moving average. The most commonly use moving averages are: 12, 50 and 200 moving average.
When a moving average cross-over or below the other moving average, it is a signal that the trend might change direction.
In the sample below, the trend change from uptrend to downtrend. The moving average of 12 (green) cross-below the moving average of 50 (red) and further confirmation that this chart is in a downtrend happened when both (12 and 50) moving average cross below the long range moving average of 200.
The 200 Moving Average is used to identify when a trend is in bull or bear territory. The 200 moving average is essential to traders as it helps to choose long or short positions. Many traders put long positions when the chart price trades above the 200 moving average and short positions below the 200 moving average.
- Based in figure 1, a trader is likely to place a short or sell order when the moving average of 12 cross-below the 50 moving average and likely to increase its position once it cross-below the 200 moving average.