Moving average analysis is a method for smoothing data lines to allow trend directions to stand out. A moving average takes
a specified series of data points and averages them to get a single point. For the next point the last data element is eliminated,
the next data element is added and the average is recalculated and so on. This is called a simple moving average.
Another
type of moving average is the exponential moving average. In this type of analysis, greater emphasis is given to the more
recent prices than the older prices by weighting them higher. This type of analysis is quicker acting than a simple moving average
but may give false signals.
The power of moving average analysis comes from the combination of several averages into one picture.
For instance the combination of a 200 day average with a 100 day average. Where the 100 day average crosses over the 200 day
fortells a possible trend emerging.
Most charting softwares, including those built into online brokerages, have moving averages.
What these packages do not tell you is what average to use. It is up to you, the investor, to figure that out for yourself.
Some securities work best with simple moving averages while other need to use an exponential average. Some large growth
stocks use a 100 day average while a small young company may work best with a 20 or 50 day average. Track the stock, mutual
fund, commodity for a while to determine which is best. The easiest way to do this is time travel. That is, take past
price performance and compute the various averages and see which is closest to reality. A simple program like EXCEL can do this
for you.
Moving averages can also be combined with technical analysis to give confirmation of already suspected trends.
Moving
averages are both simple and complex and virtually every trader uses them to round out her investing toolbox.
