Traders and investors frequently use Moving average in their trading to forecast and analyze market trends. Moving average is a mathematical calculation that represents the average price that is continuously updated over a given period of time. Moving average provides average based on the historic price movements, and thereby we can understand it is a lagging indicator. Moving averages can be used by traders to identify trends and potential reversal points in market. Simple moving averages (SMA) and exponential moving averages (EMA) are the two most used moving averages. Both Simple moving average and Exponential moving average are overlay indicators, that is they are plotted on the top of the chart.
Moving Average
Moving Average is a technical indicator where average of previous prices is taken to compare with the current price to understand the direction of an asset.
- Simple Moving Average (SMA) and Exponential Moving Average (EMA) are the popular and most used moving averages.
- Simple Moving Average is the arithmetic average of an asset over a period of time.
- Exponential Moving Average is similar to simple moving average but it gives more weightage to recent price of an asset
- Moving average is a Lagging indicator as it is based on historic price of an asset.
Simple Moving Average
Simple Moving Average is calculated by combining the average closing price of an asset over a period of time. Simple moving average is derived by combining the average closing price of an asset over a period of time, Average moves as the data changes and new price data are added and dropped as per the time period determined.
Exponential Moving Average
Exponential Moving Average is calculated by combining the average closing price of an asset over a period of time giving more weightage to recent price data. EMAs are more preferred by short term traders as they are more responsive to price movements. Investors use Simple Moving Average for understanding the longer-term trend of an asset and use Exponential Moving Average for understanding shorter-term trends of an asset.
Understand Moving Average Cross over strategy
Let’s understand Moving average cross over strategy with a live example of Nifty 50 chart. Moving average is clearly visible in the image. Red Moving average indicates 200 Day moving average and Green Moving average indicates 50 day Moving average.
Bullish cross over
Bullish crossover strategy is used by traders and investors when the 50-day moving average crosses over 200 day moving average. Bullish Cross over indicates buying momentum in market and traders takes long positions in market expecting bullishness. When we analyse Nifty 50 in the above image, we can see that after the bullish crossover has happened, the price was moving up strongly. Different traders use different time frames for moving average, however 50 and 200 moving average is the most popular and widely used moving average time frames. Legendary investors mention 50 day and 200 day Moving average bullish crossover as Golden crossover and consider this as a best buying opportunity.
Bearish Cross Over Strategy
Bearish cross over strategy is used by traders and investors when the 50-day moving average crosses down the 200-day moving average. Bearish cross over indicates weakness and bearishness in an asset. Traders takes short positions in market expecting the asset to move down after a bearish crossover. While Analysing the Nifty 50 chart, we can see that Nifty 50 has been moving down strongly after the bearish crossover. Legendary investors consider bearish crossover to book profits and mention 50-day 200-day bearish crossover as Death crossover.
Moving Average acts as Support and Resistance
Moving average of an asset acts as a support and resistance while trading. If the stock or an asset is trading above moving average it tends to act as a Support and if the asset is trading below moving average, it acts as a Resistance. Let’s understand with a live example of Nifty 50 chart. In the image, we can clearly see that Nifty 50 is taking support at multiple levels of 50 day moving average (Green). Traders and investors uses Moving average as strong support and resistances to make intelligent decisions in market to make better trading outcome.
Application
- Moving Averages are applied to identify the trend direction of an asset
- Moving averages are applied to understand the support and resistance levels of an asset.
Moving Average Application According To Time Frame
LONG TERM – 50 DAY, 200 DAY
SHORT TERM – 50 DAY, 100 DAY
INTRADAY – For intraday trading , 20 and 50 Exponential moving average or simple moving average is commonly used.
Check out this article to understand about different types of technical indicators
