Moving Averages
A moving average (MA) is a technical analysis indicator that helps smooth out price action by filtering out the “noise” from random price fluctuations. It is a trend-following, or lagging, indicator because it is based on past prices. 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 greater weight to more recent prices. Moving averages lag because they are based on past prices. As a result, the fast-moving average will react more quickly to price changes than the slow-moving average.
History of Moving Averages
The concept of a moving average was first introduced by Dow Theory pioneer Charles Dow in the late 19th century. Dow believed that the average price of a stock over a period of time could be used to identify the trend of the stock. He used a simple average of the closing prices of the previous 10 days to identify the trend. Since then, moving averages have become one of the most widely used technical indicators in trading.
Comparison of Moving Averages
| Type | Calculation | Reaction Time |
|---|---|---|
| Simple Moving Average (SMA) | Sum of closing prices over a given period of time divided by the number of periods | Slow |
| Exponential Moving Average (EMA) | Weighted average of closing prices over a given period of time | Fast |
Summary
Moving averages are a popular technical analysis tool used to identify trends in stock prices. They are lagging indicators, meaning they are based on past prices, and are used to smooth out price action by filtering out the “noise” from random price fluctuations. The two most commonly used moving averages are the simple moving average (SMA) and the exponential moving average (EMA). For more information on moving averages, visit Investopedia, The Balance, and Investing.com.
See Also
- Exponential Moving Average (EMA)
- Simple Moving Average (SMA)
- Bollinger Bands
- Relative Strength Index (RSI)
- Stochastic Oscillator
- MACD
- Parabolic SAR
- Fibonacci Retracements
- Average Directional Index (ADX)
- On Balance Volume (OBV)
