Moving Average (MA) is perhaps the oldest and the most widely used technical indicator. It shows the average value of a security's price over time.Moving averages can be calculated in a number of ways.
A simple moving average is calculated by adding the prices over a given number of periods, then dividing the sum by the number of periods. For example, a nine-day simple moving average would add together the closing prices for the last nine days, and then divide that number by nine.
An exponential moving average gives more weight to recent prices, and is calculated by applying a percentage of today's closing price to yesterday's moving average. The longer the period of the exponential moving average, the less total weight is applied to the most recent price. The advantage to an exponential average is its ability to pick up on price changes more quickly.
Moving averages are very flexible, and can be incorporated into most trading and investment philosophies.
One thing to keep in mind is the shorter the time period, the more reactionary a moving average becomes. A 10-day moving average is much more sensitive to moves than a 50-day moving average. However, a shorter period also means that you may have a greater number of false moves within an existing trend, what is considered "market noise" or a "whipsaw".
Moving averages can be used to evaluate trends in both the short-term and long term. A typical short term moving average ranges from 5 to 25 days, an intermediate-term from 25 to 100, and long-term 100 to 250 days.
The formula for an exponential moving average is as follows:
Exponential Percentage = 2/Time Period + 1
Therefore, a 50-day EMA will have a 3.9 % exponential average. .039 = 2/50 + 1
This means that the most recent day will be weighted 3.9% of the value of the EMA. For a 50-day simple moving average, each day has precisely a 2% weight.
There are two major ways moving averages are used.
First, the moving average can be compared to the price. If the price rises above the moving average it can be considered a bullish signal, and if the price dips below the moving average, it can be considered a bearish signal. This "crossover" or "penetration" will not be at the top or bottom, but normally shortly after the price bottoms out or tops out.
Second, longer-term and shorter-term moving averages can be compared to each other, and generate signals when they cross. When a shorter term MA moves across a longer term MA and both slopes go up, it can be considered a bullish signal. When a shorter term MA moves across a longer term MA and both slopes go down, it's can be considered a bearish signal.
More on Moving Averages
Here are some of the most popular moving averages.
The 10 day moving average is often used for the shorter term trend.
The 20 day moving average is often used for market swings.
The 50 day moving average is often used for intermediate moves.
The 200 day moving average is often used as the bull and bear market average.
As you can well imagine traders will use every number possible looking
for the perfect moving average, but I am one that just likes to stick to the basics.
I for the most part use the above moving averages.
The 18 and 40 day moving averages are popular
and if you like the look of those better than the 20 and 50 that is fine.
Moving averages are mostly used for showing the different trends
and sometimes one might work better than another,
but usually the 18 and 20 will give you pretty much the same information,
as would the 40 and 50 if you looked at them.
I've even heard of people spliting the difference
of the 40 and 50, for eaxmple and using a 45 day moving average.
Like I said there is no right answer, and it is what you are most comfortable with.