A moving average smooths out price data by creating a constantly updated average price over a specific period. It is the foundation of many technical indicators and one of the most versatile tools in a trader's toolkit.
Types
- Simple Moving Average (SMA): Equal weight to all prices in the period. The 200-day SMA is the most widely followed long-term trend indicator
- Exponential Moving Average (EMA): Gives more weight to recent prices, making it more responsive to new information. Preferred by short-term traders
- Weighted Moving Average (WMA): Linearly weighted, with the most recent prices having the highest weight
- Volume-Weighted Moving Average (VWMA): Weights prices by trading volume
Key Periods and Their Uses
- 10/20-day: Short-term trend. Used by swing traders
- 50-day: Medium-term trend. Institutional benchmark β many funds have rules tied to the 50-day
- 100-day: Intermediate trend filter
- 200-day: Long-term trend. Often acts as major support/resistance. When price is above the 200-day, the market is in a long-term uptrend; below, a downtrend
Trading Strategies
- Moving Average Crossover: When a faster MA crosses above a slower MA (e.g., 50-day above 200-day = Golden Cross), it signals a bullish trend change
- Dynamic Support/Resistance: MAs act as support in uptrends (buy at the 50-day pullback) and resistance in downtrends
- Moving Average Envelope: Bands plotted at a fixed percentage above/below an MA
Limitations
MAs are lagging indicators β they follow price, not predict it. In choppy markets, prices constantly cross above and below MAs, generating unreliable signals. The 'best' period depends entirely on the market and timeframe being analyzed.