Moving Average is a widely used indicator in technical analysis that helps smoothen price action by improving the signals from random price fluctuations.
A moving average (or MA) is a trend-following indicator because it is based on past prices.
Moving Averages are the foundation of technical analysis.
These functions calculate averages or variations of averages of an underlying sector.
Many technical indicators rely upon the smoothing features of moving averages as part of their calculation.
Some of the most important functions of a moving average are to identify trends and reversals, measure the strength of a financial asset’s momentum and determine areas reflecting high potential where an asset will find support or resistance.
Moving averages are one of the oldest and most popular technical analysis tools.
A moving average can be defined as the average price of a security at a given time.
When calculating a moving average, you specify the time span to calculate the average price.
The two basic and commonly used Moving Averages are: the Simple Moving Average (SMA), which is, “the simple average of a security over a defined number of time periods, and the Exponential Moving Average (EMA), which gives bigger weight to more recent prices.”
The common properties of Moving Average are to identify the trend direction and to determine support and resistance levels.
While Moving Averages are useful enough on their own, they form the foundation behind the functionality of technical indicators such as the Moving Average Convergence Divergence (MACD).
Moving Average Convergence Divergence (MACD).
Trend-following momentum indicator that marks the relation between two moving averages of prices.
Technical indicators like the MACD helps to calculate the comparative difference between two moving average of the prices.
It also measures the momentum of the price movement and signals the current direction of the momentum by measuring the difference between the short-term and the long-term momentums.
Moving averages are known to smoothen the price data to form a trend following indicator.
They do not predict price direction, but help in defining the current direction with a delay.
Moving averages delay due to their emphasis on past prices.
Despite this delay, moving averages help smooth price action and filter out the noise.
They also form the building blocks for many other technical indicators and overlays, such as Bollinger Bands, MACD and the McClellan Oscillator.
How is it calculated?
“The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA.
A nine-day EMA of the MACD, called the “signal line”, is then plotted on top of the MACD, functioning as a trigger for buy and sell signals.”
The indicator follows trends and indicates momentum while showing the comparative difference between two moving average of the prices.
It is able to do so due to the existence of two EMAs or Exponential Moving Averages in its system.
At the same time, the MACD-Histogram (Moving Average Convergence Divergence Histogram) is used measure buy and sell signals and to signal the end of such a pullback or bounce.
Properties of MACD Indicator
- A moving average is a lagging indicator which maps trends as it is based on past prices.
- Moving Average identifies the trend directions determines support and resistance levels.
- A rising Moving Average indicates that the stock is in an uptrend, while a declining Moving Average indicates that it is in a downtrend.
- The two commonly used Moving Averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).
- When the stock price diverges from the MACD, it gestures the end of the existent trend.
- When the MACD falls below the signal line, it indicates a bearish market or the time to sell.
- At the same time, if the MACD rises above the signal line, it indicates a bullish market or upward trend of the price movement.
- If the MACD is seen to be rising abruptly, it signals the overbuying of stocks, thus indicating a quick return to the normal levels.
There are three common methods to interpret MACD.
It has been noted that when the MACD falls below the signal line on a chart, it indicates a bearish signal, which in turn indicates that it may be time to sell.
In the same way, when the MACD rises above the signal line, this indicates a bullish signal, which suggests that the price of the asset is likely to experience upward momentum.
Many traders wait for a confirmed cross above the signal line before entering into a position to avoid entering into a position too early.2. Divergence
When the security price diverges from the MACD, it signals the end of the current trend.
This is known as Divergence.3. Dramatic Rise
When the MACD rises dramatically as the shorter moving average pulls away from the longer-term moving average, the shift is known as a “dramatic rise”.
It indicates that the security is overbought and will soon return to normal levels.
This section of the article provides a brief conclusion of all the important points that have been discussed through the course of this article.
The moving average is one of the most popular technical indicators used in the market.
Though Moving Averages exist in several forms, their underlying purpose remains the same throughout: to help technical traders track the trend of financial assets by smoothening out the day-to-day trading price fluctuations.
A moving average can be a great risk management tool because of its ability to identify strategic areas to stop losses.
Using moving averages can be very ineffective during periods where the asset is trending sideways.
There are many different strategies involving moving averages.
The most popular is the moving average crossover.
Nevertheless, like all other trading strategies and approaches available in the market, Moving averages won’t solve all your investing problems.
However, when used judiciously, they can be valuable tools in planning your trading strategy.Our website provides an in-depth video on Technical Analysis and the various elements (like Moving Averages) which can help a trader design a successful trading strategy. To read up more on Investment Strategies and the various market nuances associated with them, go to : http://stockmarketsignals.com/how-to-invest/