≈ Learn the math behind the magic ≈
Moving averages started as a simple indicator for measuring trends. Over time, traders have experimented with a dozen different ways of slicing and dicing the data (ever heard of a displaced exponential moving average?), but we find little value in trying to improve on perfection.
Let’s start with the “average” piece first. Suppose you’re trying to calculate the average price for the past ten trading sessions. Add up the closing price for each of the past ten sessions, and then divide by ten. Suppose this is your data set:
Add them up, divide by ten, and you get 5.5.
That is the simple average. Note how each data point had equal weight in the calculation. Yesterday’s close had the same impact as the close of ten days prior.
Now, what of the “moving” part of a moving average?
It refers to the fact that the average is recalculated to consider the most recent day’s close. And, as you add a new data point, an old one drops off. Suppose the above stock closes at 9 on the very next day. We would recalculate the 10-day moving average. But now the 3 drops off because it was eleven days ago.
Recalculating the average yields 6.1.
If we plotted the new reading of the 10-day average, it would move from 5.5 to 6.1. Over time, the average will climb or fall as a reflection of the price’s trend.
Chart of the Day
SPY Daily Chart
Here is a chart example of the S&P 500 ETF with 20-day, 50-day, and 200-day simple moving averages. They are all rising to signal buyers control the short-term, intermediate-term, and long-term market trends.
Video of the day
Trading Basics: Moving Averages
Coach Tim at Tackle Trading teaches how to use Moving Averages. Enjoy!
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