A moving average is one of the most versatile and widely used of all of the technical indicators. Because of the way it is created it is easily quantified and tested. A moving average is used with many mechanical trend based systems.
Interpreting charts can be an subjective endeavour because what I may interpret on a chart maybe different from someone else. Moving averages however are precise and give definite trading signals.
We create a moving average by using the markets closing prices. All market movement is displayed in bars and the number of bars in our moving average creates different sensitivities. A moving average is the number of closing prices divided by the number of bars.
10 bar moving average would add up all of the closing prices from the previous 10 bars. This total is then divided by 10 to give us our moving average. As the market develops more bars are added and these new bars are added to the moving average and the oldest bars are removed. This produces a continuous line on our charts.
We use a moving average to help us identify a trend. Because the sensitivity of the moving average is dictated by the number of bars. A 20 bar moving average changes direction quicker than a 100 bar moving average.
Once we are aware of this sensitivity we need to know how this affects our trading. A moving average with a low number of bars is very sensitive and can give lots of false trading signals. The advantage however is that we are entering trends very early and when we do get a trend our profit potential is increased.
When we use a moving average with a larger amount of bars we reduce the number of false signals. However we sacrifice some potential profit from the trend. Therefore the length of the moving average we use depends on our trading style.
How does the moving average produce trading signals? Say we have a 25 bar moving average and the market is rising. We are waiting for the market to rise and cross our moving average line. As soon as a bar closes higher than our moving average we have a buy signal.
When the market is falling we are looking for it to move below our moving average. When this happens we wait until the bar closes and we have our sell signal. We can use the moving average to act as a conformation signal. To do this we must wait until the moving average has turned to match our new trend. When we are looking to make a buy we wait until the moving average turns up on our chart. Therefore confirming our trend. The same is true for a down-trend but in reverse.
Interpreting charts can be an subjective endeavour because what I may interpret on a chart maybe different from someone else. Moving averages however are precise and give definite trading signals.
We create a moving average by using the markets closing prices. All market movement is displayed in bars and the number of bars in our moving average creates different sensitivities. A moving average is the number of closing prices divided by the number of bars.
10 bar moving average would add up all of the closing prices from the previous 10 bars. This total is then divided by 10 to give us our moving average. As the market develops more bars are added and these new bars are added to the moving average and the oldest bars are removed. This produces a continuous line on our charts.
We use a moving average to help us identify a trend. Because the sensitivity of the moving average is dictated by the number of bars. A 20 bar moving average changes direction quicker than a 100 bar moving average.
Once we are aware of this sensitivity we need to know how this affects our trading. A moving average with a low number of bars is very sensitive and can give lots of false trading signals. The advantage however is that we are entering trends very early and when we do get a trend our profit potential is increased.
When we use a moving average with a larger amount of bars we reduce the number of false signals. However we sacrifice some potential profit from the trend. Therefore the length of the moving average we use depends on our trading style.
How does the moving average produce trading signals? Say we have a 25 bar moving average and the market is rising. We are waiting for the market to rise and cross our moving average line. As soon as a bar closes higher than our moving average we have a buy signal.
When the market is falling we are looking for it to move below our moving average. When this happens we wait until the bar closes and we have our sell signal. We can use the moving average to act as a conformation signal. To do this we must wait until the moving average has turned to match our new trend. When we are looking to make a buy we wait until the moving average turns up on our chart. Therefore confirming our trend. The same is true for a down-trend but in reverse.
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